Last week, on May 15, the Centers for Medicare & Medicaid Services (CMS) issued a proposed rule that, if adopted, will change the standards by which states obtain waivers for health care-related provider taxes used to finance Medicaid. The proposal is aimed at closing a regulatory “loophole” that CMS believes allows states to shift Medicaid financing burdens to the federal government without meeting the statutory intent of redistributive tax structures.

CMS will be accepting public comments on the proposed rule until July 14, 2025.

Background

Under 42 U.S.C. § 1396b, states receive federal Medicaid funding based on the Federal Medical Assistance Percentage (FMAP). When a state imposes a health care-related tax on providers, the resulting revenue typically reduces the amount of federal matching funds the state can claim. However, this reduction does not apply if the tax is both broad-based (applied to all providers within a specified class) and uniform (applied at the same rate across all providers in that class) so long as there are no hold-harmless provisions that offset the providers’ tax burden.

If a provider tax does not meet the broad-based or uniformity requirements, a state may request a waiver of those requirements from the Federal government. To qualify, the state must demonstrate that the tax is generally redistributive, meaning that it equitably spreads the tax burden across providers, and that the tax is not directly tied to Medicaid payments for the services being taxed.

Proposed Changes

CMS now argues that the current statistical methods used to assess whether a tax is generally redistributive, known as the P1/P2 and B1/B2 tests, are inadequate and susceptible to manipulation. For background, the P1/P2 test applies on a per class basis to a tax to evaluate whether it is generally redistributive, if the state seeks a waiver of the broad-based tax requirement, and the B1/B2 test applies also on a per class basis but to non-uniform taxes, if the state seeks a waiver of the uniform tax requirement.

The proposed rule introduces new conditions that must be met even if the P1/P2 and B1/B2 tests are satisfied. Specifically, a tax will no longer be considered generally redistributive if:

  • The tax rate on Medicaid-related units is higher than on non-Medicaid units within the same provider class.
    • Example: “[A]n MCO tax where Medicaid member months are taxed $200 per member month whereas the non-Medicaid member months are taxed $20 per member month would violate this requirement.”
  • Providers with higher Medicaid volume face higher tax rates than those with lower Medicaid volume.
    • Example: “[A] tax on nursing facilities with more than 40 Medicaid-paid bed days of $200 per bed day while nursing facilities with 40 or fewer Medicaid-paid bed days are taxed $20 per bed day would violate this requirement.”
  • The tax uses indirect characteristics (such as income levels or provider types) as a proxy to impose higher taxes on Medicaid-serving providers.
    • Example: “[A] tax on inpatient hospital service discharges that imposes a $10 rate per discharge associated with beneficiaries covered by a joint Federal and State health care program and a $5 rate per discharge associated with individuals not covered by a joint Federal and State health care program would violate this requirement, because joint Federal and State health care program describes Medicaid, and a higher tax rate is imposed on Medicaid taxable units.”
    • Example, in contrast: “A tax structure that excluded rural providers without any explicit reference to Medicaid would likely not fall within the proxy provision . . . because the provider group would be defined by a pre-existing classification that exists for various public policy purposes apart from taxation (rural location) . . ..”

To support the implementation of these changes, CMS proposes new definitions. A “Medicaid taxable unit” would refer to any unit taxed under a health care-related tax that is applicable to the Medicaid program, such as Medicaid bed days, revenue, or charges. Conversely, a “non-Medicaid taxable unit” would refer to units taxed within a health care-related tax that is not associated with the Medicaid program.

Impact and Transition

The proposed rule offers a transition period for certain states. States with existing health care-related tax waivers approved more than two years prior to the effective date of the final rule will be required to either: (1) submit a new waiver proposal that complies with the revised standards, or (2) modify their tax structure to align with the new requirements, with the revised tax becoming effective no later than the start of the first state fiscal year beginning at least one year after the final rule’s effective date.

However, states with tax waivers approved less than two years before the effective date of the final rule will not have such an opportunity to modify or resubmit and may be subject to a reduction in their claimed medical assistance expenditures if their existing tax structure fails to meet the new redistributive criteria. This means the federal government could deduct the value of non-compliant tax revenue from the state’s federal Medicaid funding, increasing the state’s financial responsibility.

Reed Smith will continue to monitor developments in the regulation of Medicare and Medicaid payments. If you have any questions about this development or would like to comment on the proposed rule. Please reach out to the authors of this post or to the health care lawyers at Reed Smith.