CMS Finalizes Rule Prohibiting Certain Non-Uniform Provider Taxes, Including New Compliance Deadlines

Anne Karl, Avi Herring, and Emily Polk, Manatt Health

On January 29, the Centers for Medicare & Medicaid Services (CMS) finalized the rule, “Medicaid Program: Preserving Medicaid Funding for Vulnerable Populations – Closing a Health Care-Related Tax Loophole.” The rule codifies H.R.1’s (P.L. 119-21) prohibition on certain healthcare-related (provider) taxes that meet technical federal requirements but effectively shift most of the tax burden onto the Medicaid program. A number of states currently have federal approval for such provider taxes but will need to eliminate or restructure those taxes under the new rules. In addition to codifying relevant provisions in H.R.1, the final rule includes a notable update to the timeframes for states to come into compliance.

Background

Federal law requires that provider taxes are “broad-based and uniform,” meaning they apply to all providers within a given class [e.g., inpatient hospitals or managed care organizations (MCOs)] and are imposed at the same rate. States are entitled to waivers of the broad-based and uniformity requirements if they demonstrate to CMS that they meet a complex statistical test set out in regulation. The statistical test is intended to demonstrate that the tax is “generally redistributive,” meaning that it does not disproportionately shift the tax burden onto Medicaid providers.

Over the years, some states^[1] have designed taxes—often imposed on MCOs—that meet the statistical test but nevertheless tax Medicaid volume at a much higher rate than non-Medicaid utilization. Under these arrangements, states typically implement covered lives assessments that apply much higher tax rates to Medicaid managed care lives than other lives (e.g., commercial managed care). CMS has raised concerns in recent years—including prior to H.R.1’s passage—that these taxes undermine the intent of the requirement that provider taxes be generally redistributive.

H.R.1 changes provider tax rules to prohibit any tax that:

1. Imposes a lower tax rate on providers explicitly defined based on their lower Medicaid volume compared to those providers with higher Medicaid volumes;
2. Taxes Medicaid units of services (e.g., discharges, bed days, revenue, or member months) at a higher rate than non-Medicaid units of service; or
3. Has the “same effect” as (1) or (2).

CMS estimates that in 2024, states collected $24 billion in taxes impacted by the rule ($18.5 billion of which is associated with MCO taxes specifically).

Prior to H.R.1’s passage, CMS issued a proposed rule implementing these same provisions. Now, CMS has finalized the rule, codifying the statutory requirements, providing additional details on how CMS will evaluate whether a tax runs afoul of the new requirements and revising the transition periods for states to restructure non-compliant taxes.

Compliance Timeframes

H.R.1 permits CMS to grant states up to a three-year transition period to comply with the new uniformity rules, though the actual timeframes have been a moving target. In a departure from the proposals included in the proposed rule (as well as from CMS’ November 2025 preliminary guidance), the final rule outlines separate timeframes by which states need to bring their taxes into compliance.

These compliance deadlines depend on:

1. The provider class subject to the tax, requiring non-compliant MCO taxes to come into compliance faster than non-compliant taxes levied on other healthcare providers; and
2. The recency of CMS’ approval of a tax waiver for a non-compliant MCO tax, requiring compliance by the end of calendar year 2026 for MCO taxes with a waiver approval within the past two years.

The table below outlines the required compliance dates included in the final rule:

These timeframes give states with MCO taxes more time to comply with the rules compared to CMS’ November 2025 preliminary guidance, which would have required non-compliant MCO taxes to comply by the end of the SFY ending in calendar year 2026 (in states with a July-June fiscal year, this would mean complying by July 1, 2026). The timeframe for non-compliant non-MCO provider taxes in the final rule aligns with the November preliminary guidance.

Prohibited Provider Taxes

Consistent with H.R.1 and the proposed rule, the final rule prohibits states from:

• Taxing Medicaid utilization at higher rates than non-Medicaid utilization. For example, a tax on MCOs where Medicaid member months are taxed $200 per member month whereas the non-Medicaid member months are taxed $20 per member month would be
• Taxing high-Medicaid providers at a higher rate than low-Medicaid providers. For example, a tax on nursing facilities with more than 40 Medicaid-paid bed days of $200 per bed day and on nursing facilities with 40 or fewer Medicaid-paid bed days of $20 per bed day would be prohibited.
• Implementing tax structures that result in the “same effect” as the prohibited taxes described above. For example, this would prohibit a tax of $10 per inpatient hospital discharge on hospitals located in counties with an average income less than 230% of the federal poverty level, while hospitals in all other counties are taxed at $5 per inpatient hospital discharge, because the distinction between tax rate groups is associated with Medicaid eligibility and would likely result in a higher tax rate for high-Medicaid hospitals. While CMS provides examples that illustrate this “same effect” provision, it does not put forth a concrete definition, which may result in ambiguity for states going forward.

Prior to codification of the final rule, federal regulations specified that waivers for provider taxes meeting the applicable statistical test are to be “automatically” approved. The final rule modifies this language to say that tax waivers will be “approvable” by CMS should they meet the applicable statistical test and the new requirements. This distinction—coupled with the ambiguity of the “same effect” definition outlined above—may give CMS increased discretion to select which tax waivers it approves and does not approve.

Interaction with Moratorium on New or Increased Provider Taxes

H.R.1 additionally includes a prohibition on new or increased provider taxes, starting in Federal Fiscal Year (FFY) 2027. The law specifies that provider taxes grandfathered under the law will be subject to new “indirect hold harmless thresholds,” meaning they will be limited to the tax rate as a percent of net patient revenue (NPR) as of July 4, 2025.^[2] CMS’ November 2025 preliminary guidance includes initial implementation details regarding this moratorium, with formal rulemaking forthcoming.

CMS has clarified that states may modify their non-uniform taxes to comply with the new uniformity rules and still qualify for “grandfathering” under the new tax moratorium, as long as the tax does not exceed the new indirect hold harmless threshold established under the law. For example, consider a state with a covered lives assessment that taxes Medicaid managed care member months at $50 per member per month (PMPM) and non-Medicaid managed care member months at $5 PMPM, resulting in a tax rate of 5% of NPR. The state could adjust its tax to impose a uniform tax amount on all covered managed care lives (e.g., $25 PMPM), as long as the tax does not exceed 5% of NPR. While in theory states can collect the same amount of revenue absent the federal changes to broad-based and uniformity rules, it may be more difficult in practice. For example, adjusting a covered lives assessment to uniformly tax Medicaid and non-Medicaid managed care lives means increasing the tax rate on commercial managed care lives. Depending on the state, this could be challenging to implement and runs the risk of increasing premiums in the commercial market.

Next Steps for States

Even with slightly longer compliance deadlines compared to prior guidance, impacted states—particularly those with non-compliant MCO taxes—will need to act promptly to restructure their taxes or risk billions of dollars in federal matching funds. Coming into compliance will require a combination of technical policy work (for example, developing options for restructuring taxes that comply with both the new broad-based and uniformity rules and the provider tax moratorium), along with stakeholder engagement to evaluate and plan for the practical impacts on health plans, providers, and the state budget.

[1] Several states, including California, Illinois, Massachusetts, Michigan, New York, Ohio, and West Virigina, have established taxes that have garnered scrutiny.

[2] For a class where a tax did not exist prior to H.R.1’s enactment, the indirect hold harmless threshold is set at 0%.