CMS Issues Medicaid Provider Taxes Proposed Rule

The Centers for Medicare & Medicaid Services (CMS) published a Proposed Rule titled "Medicaid Program; Amending the Indirect Hold Harmless Threshold of Health Care-Related Taxes" to implement Section 71115 of H.R. 1, referred to by CMS as the Working Families Tax Cut (WFTC), by revising the regulatory framework governing provider taxes and the indirect hold harmless safe harbor. The Proposed Rule establishes the regulatory standards implementing the statute's new limitations on healthcare-related taxes used to finance the nonfederal share of Medicaid expenditures.

The Proposed Rule follows on a November 14, 2025, Dear Colleague Letter that provided preliminary implementation guidance on Section 71115. Though the proposal generally reflects the agency's earlier interpretation, it incorporates several notable revisions, including a broader interpretation of when a provider tax is considered "imposed" – including eliminating the November 2025 guidance's requirement that provider taxes generally be actively collected as of July 4, 2025 (or collected at the end of the tax year pursuant to an established collection practice) – and the proposed elimination of the long-standing 75/75 alternative compliance test. View a WFTC fact sheet.

CMS actuaries estimate that the proposal would reduce federal Medicaid spending by approximately $246 billion over 10 years. Comments on the Proposed Rule are due by September 21, 2026.

This is one of three major regulations implementing the Medicaid financing and program integrity provisions enacted in the reconciliation law. CMS previously released a Proposed Rule addressing State Directed Payments in May 2026 and a third Proposed Rule, "Strengthening the Integrity of Medicaid and CHIP," remains under review by the Office of Management and Budget.

Background

Under long-standing federal regulations, provider taxes have been permissible if they are broad-based and uniform and do not include a prohibited "hold harmless" arrangement, under which providers are effectively repaid for the taxes they contribute. Historically, states have satisfied the indirect hold harmless test if provider tax revenues did not exceed 6 percent of providers' net patient revenues. Provider taxes have long served as an important financing mechanism that states use to fund the nonfederal share of Medicaid expenditures.

WFTC fundamentally restructures the Medicaid provider tax framework by replacing the long-standing uniform 6 percent indirect hold harmless threshold with class-specific limitations based on provider taxes that were both enacted and imposed as of July 4, 2025. Section 71115 of the WFTC establishes a new indirect hold harmless threshold for provider taxes, effective for fiscal years beginning on or after October 1, 2026. Under Section 1903(w) of the Social Security Act, provider taxes must be imposed on a permissible class of healthcare items or services, broad-based (generally applying to all non-federal, non-public providers within the permissible class) and uniform (generally applying at the same tax rate for all taxed providers). The statute also prohibits direct and indirect hold harmless arrangements that guarantee taxpayers will be held harmless. Under existing CMS regulations, a provider tax generally satisfies the indirect hold harmless prohibition if it falls below a specified percentage of net patient revenues. Section 71115 preserves this regulatory framework while replacing the longstanding uniform threshold with class-specific statutory limitations applicable to each permissible class of healthcare items and services.

Since 2011, the indirect hold harmless threshold has been set at 6 percent of net patient revenues. Provider taxes that exceed that threshold may instead qualify under the 75/75 test, although CMS notes that the test has rarely been satisfied in practice.

Beginning with fiscal years starting on or after October 1, 2026, Section 71115 replaces the current uniform national indirect hold harmless threshold with an applicable percentage calculated separately for each permissible provider tax class based on taxes that were enacted and imposed as of July 4, 2025. Under the statute, states that had not enacted and imposed a provider tax for a particular permissible class of healthcare items or services as of July 4, 2025, generally will not be permitted to establish a new provider tax for that class because the applicable percentage is zero percent.

Medicaid expansion states face an additional statutory limitation. Beginning in federal fiscal year (FFY) 2028, those states must comply with the lower of the revised class-specific threshold or a statutory percentage that phases down by 0.5 percentage points annually until reaching 3.5 percent in FFY 2032.

Highlights of the Proposed Rule

Revised Indirect Hold Harmless Threshold Calculation

CMS proposes replacing the current two-step methodology for evaluating indirect hold harmless arrangements with a single "applicable percent" standard. For FFY 2027, the applicable percentage would equal the level of provider taxes that were both enacted and imposed as of July 4, 2025, calculated on a statewide basis for each permissible provider tax class. CMS further clarifies that all references to "fiscal year" in H.R. 1 pertain to the FFY. As discussed above, Medicaid expansion states would be subject to an additional multiyear phasedown beginning in FFY 2028, requiring provider tax rates that exceed the applicable threshold to be reduced over time.

Revised Interpretation of "Enacted" and "Imposed"

One of the most significant changes from CMS' November 2025 guidance involves the agency's interpretation of the statutory terms "enacted" and "imposed." Under the Proposed Rule, CMS adopts a more flexible approach, particularly for provider taxes requiring broad-based or uniformity waivers. CMS would recognize waivers approved after July 4, 2025, provided they have a retroactive effective date of July 4, 2025, or earlier. In addition, CMS would no longer require that provider taxes have been actively collected as of July 4, 2025 – or, consistent with the November 2025 guidance, collected at the end of the tax year pursuant to an established collection practice – to be considered "imposed." The Proposed Rule also eliminates the prior requirement that states be actively collecting provider tax revenues as of July 4, 2025.

Under the November 2025 guidance, CMS interpreted "enacted" to require completion of the legislative process necessary to authorize the provider tax, including approval of any required broad-based or uniformity waiver, by July 4, 2025. CMS also interpreted "imposed" to require states to be actively collecting provider tax revenues as of that date (or to collect the tax at the end of the tax year pursuant to an established collection practice) and appeared to credit only provider tax rates based on revenues actually collected by July 4, 2025.

The Proposed Rule revises the "enacted" approach taken in the November 2025 preliminary guidance by relocating the provider tax waiver approval requirement to the separate "imposed" requirement and by allowing provider taxes with broad-based or uniformity waivers that were approved by CMS after July 4, 2025, but with retroactive effective dates prior to July 4, 2025, to be considered "enacted and imposed," and thus permissible under H.R. 1.

In short, under the Proposed Rule, "enacted" would mean the state or locality completed the legislative process to authorize the tax structure in effect on July 4, 2025, and "imposed" would mean the tax was in effect on July 4, 2025, and that any required waiver has been approved with retroactive effective dates of July 4, 2025, or earlier. The "imposed" requirement would no longer include the "active collection" requirement as included in the November 2025 Guidance.

Elimination of the 75/75 Alternative Compliance Test

Beginning October 1, 2026, CMS proposes to eliminate the alternative 75/75 indirect hold harmless test, leaving the new class-specific threshold as the sole method for satisfying the indirect hold harmless safe harbor. CMS states that retaining the 75/75 test could undermine the U.S. Congress' newly established class-specific thresholds by allowing taxes above those thresholds to remain permissible through an alternative compliance pathway. States with a CMS-approved threshold above 6 percent under the 75/75 test as of July 4, 2025, would be permitted to retain that higher tax rate, subject to the statutory phasedown applicable to Medicaid expansion states.

New Permissible Class for Health Insurers

CMS proposes establishing a new permissible provider tax class for "services of health insurers," separate from the existing permissible class for managed care organization services. Unlike the other major provisions of the Proposed Rule, this new permissible provider tax class is not expressly required by WFTC Section 71115. Rather, CMS is exercising its existing regulatory authority to create the new class, explaining that many states currently impose taxes on health insurers without an explicit permissible-class designation under existing regulations. CMS notes that many states currently impose taxes on health insurers without an explicit permissible-class designation under existing regulations and proposes the new class to address those arrangements. The new class would be subject to the same threshold and phasedown framework, with an applicable threshold of zero percent for taxes that were not enacted and imposed by July 4, 2025.

Enhanced Reporting Requirements

The Proposed Rule would significantly expand provider tax reporting requirements. States would be required to submit one-time interim reports covering provider tax and net patient revenue data for the state fiscal year containing July 4, 2025, using best available or estimated data, by December 31, 2026. Final reports using actual data would be due by June 30, 2028.

Beginning October 1, 2026, states also would be required to submit quarterly reports identifying provider tax collections, the use of provider tax revenues and whether public providers are exempt from the tax to assist CMS in calculating applicable thresholds and monitoring compliance with the revised provider tax requirements.

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