CMS proposes closing the “loophole” on Medicaid state directed provider tax payments

The Centers for Medicare & Medicaid Services (CMS) has issued a proposed rule designed to strengthen the agency’s oversight of Medicaid state directed provider tax payments (Proposed Rule).

According to CMS, the Proposed Rule targets a “loophole” in the provider tax waiver process and addresses concerns about potential “money laundering,” as described in the accompanying press release. Specifically, the Proposed Rule seeks to prevent situations where, in CMS’s view, state provider taxes exploit the federal Medicaid match system “by taxing a type of entity, drawing down a high federal match and then redistributing those dollars back to the very same entities that were taxed.” CMS contends that this practice increases federal outlays without a corresponding financial commitment from the states.

Under federal law, states are allowed to impose provider taxes that are both broad-based and uniform. “Broad-based” means the tax applies to an entire class of allowable healthcare items and services, while “uniform” indicates that the tax rate is the same rate for all items, services or providers within that class. Section 1903(w)(3)(E) of the Social Security Act allows a healthcare related tax waiver to be approved for the broad-based or uniformity requirements if the net impact of the tax and related expenditures is “generally redistributive” in nature and the amount of the tax is not directly correlated to Medicaid payments for items and services for which the tax is imposed. And it is these waivers that appear to have pushed CMS to the edge. 

Key provisions of the Proposed Rule

At its core, the new formulas and analyses are intended to: 

• Prohibit states from taxing Medicaid businesses at higher rates than non-Medicaid businesses
• Prevent states from using “vague language” to tax Medicaid businesses at higher rates than non-Medicaid businesses
• Change the current statistical test for deciding and approving waiver compliance with uniformity and redistributive requirements

The current statutory and regulatory framework has two statistical tests to which the state must adhere: (1) a “P1/P2” test for the “broad-based requirement;” and (2) a “B1/B2” test for the “generally redistributive” requirements. The Proposed Rule focuses on the B1/B2 test, and importantly, the preamble narratively describes the arrangements it considers exploitative of the federal match. 

CMS aims to prevent states from imposing higher tax rates on Medicaid activities compared to commercial activities, even if the state meets the B1/B2 test. To clarify this, the Proposed Rule provides an example of a tax structure that would violate this new requirement: “… a tax on hospitals with less than 5% Medicaid utilization at 2% of net patient revenues for inpatient hospital services, and on all other hospitals at 4% of net patient service revenues for inpatient services would violate [the Proposed Rule].” 

Implications for healthcare providers

CMS has identified four recent state waivers in the press release—California, Michigan, Massachusetts and New York—as examples of states that are taking advantage of the Medicaid provider tax. Additionally, the Proposed Rule refers to seven unnamed states that have "existing loophole waivers" or "problematic" tax structures. Thus, suggesting the Proposed Rule could ultimately extend beyond these states and impact various programs and arrangements nationwide.

Healthcare providers should carefully review their state’s Medicaid waivers and directed payment provider tax programs to assess whether they may be vulnerable to an adverse interpretation under the Proposed Rule. Stakeholders who wish to provide input on the Proposed Rule must submit their comments to CMS no later than July 14, 2025.

Our team of experienced lawyers and professionals at Norton Rose Fulbright will closely watch the development and finalization of the Proposed Rule. If you have any questions related to Medicaid state directed payment provider tax programs, please do not hesitate to contact us.