The Centers for Medicare and Medicaid Services (CMS) has finalized a rule that puts in place restrictions on how states can tap into provider and managed care organization (MCO) taxes to fund the state’s share of Medicaid spending.

CMS sees the so-called loophole closure as a dollar and cents move, with the agency declaring the taxes have generated $24 billion annually for seven states, while these states have positioned more of the costs of Medicaid to the federal government. The agency said the final rule should save $78 billion over the next decade.

According to a 2025 report by the Kaiser Family Foundation (KFF), CMS specifically named California, Massachusetts, Michigan, and New York as four of the seven states targeted for their specific provider tax protocols, with KFF and other researchers eyeing Illinois, Ohio, and West Virginia as the three remaining states. 

Use of Taxes

Medicaid statutes say states are required to finance at least 40 percent of the non-federal share of Medicaid spending. To do this, states often assess commonly provider taxes on entities like hospitals, skilled nursing facilities, and Medicaid MCOs, which are then matched with federal funds, CMS said.

Federal law allows these types of taxes if they are uniform or broad-based, or generally redistributive, or in other words do not overly burden Medicaid providers or plans. If a state wishes to deploy non-uniform taxes, states have to seek waivers from the feds and pass a statistical test.

CMS has found issue with states that while they passed the waiver’s statistical test have used a loophole to impose much higher tax rates on Medicaid business than on comparable non-Medicaid business and then used provider taxes to draw down enhanced federal matching funds. Thus, CMS says, the states in fact repaid the taxed entities with federal dollars and kept surplus funds for their own needs.

CMS Acts on Loophole

For background, CMS said on May 12, 2025, it issued a proposed rule that would end states’ ability “to exploit a health care-related tax loophole currently used by seven states to generate billions in federal Medicaid payments—without contributing their fair share or expanding care for Medicaid enrollees.”

These states impose higher taxes primarily on the Medicaid business of MCOs, although there are similarly situated current Medicaid loophole taxes on other providers, such as hospitals and nursing facilities, CMS said.

“After imposing the tax disproportionately on Medicaid plans or providers, the states effectively reimburse these entities entirely with federal matching funds, while avoiding any state financial cost. This, in turn, allows the states to use the surplus for other purposes—including the expansion of healthcare coverage for illegal immigrants. This effectively means federal money is financing these other interests, instead of enhancing the state Medicaid program.” 

Fast forward to July 4, 2025, when President Trump signed the Working Families Tax Cuts legislation and adopted the policies of the proposed rule on provider taxes and allowances for transition periods for states to adapt to.

What the Final Rule Does

CMS outlined the following actions in the final rule:

-          The rule prohibits higher tax rates on Medicaid than on non-Medicaid business to ensure states don’t exploit an inadvertent mathematical loophole in the applicable statistical test. The rule also bars the use of vague language or complex designs to disguise taxes that target Medicaid. Based on how recently the state’s tax waiver was last approved and the permissible class, the rule provides states at least until the end of calendar year 2026, and in some cases the full three years authorized by Congress. 

According to analysis by Grant Beebe, the director of Medicaid policy for the American Health Care Association, CMS has created a three-track timeline:  

• MCO taxes with recently approved waivers must move first and comply by the end of the calendar year 2026.  

• MCO taxes with older waivers receive additional runway, extending through the end of the first state fiscal year that begins at least one year after April 3, 2026.  

• All non-MCO provider taxes, regardless of waiver age, have the longest transition period and may remain in place through the end of the state fiscal year ending in calendar year 2028, but no later than Sept. 30, 2028.  

Read the CMS final rule at https://tinyurl.com/5n7hs4hb.

Questions or comments? Contact Patrick Connole at pconnole@parkplacelive.com.