The Centers for Medicare & Medicaid Services (CMS) has finalized a major Medicaid financing rule aimed at closing what the agency has described as a long-standing “healthcare-related tax loophole.” The rule, finalized on January 29, 2026, implements statutory changes enacted last summer and significantly restricts how states may use provider and managed care organizations (MCO) taxes to fund their share of Medicaid expenditures.

According to CMS, the affected financing arrangements have generated roughly $24 billion annually for a small number of states and shifted and increasing share of Medicaid costs onto the federal government. CMS estimates the final rule will save more the $78 billion over the next decade.

Background: How Provider Taxes Are Supposed to Work

Under the Medicaid statute, states are required to finance at least 40 percent of the non-federal share of Medicaid spending. States commonly meet this obligation through provider taxes, including taxes on hospitals, nursing facilities, and Medicaid MCOs, which are then matched with federal funds.

Federal law permits these taxes only if they are:

• Uniform or broad-based, or
• Generally redistributive, meaning they do not disproportionately burden Medicaid providers or plans.

To apply non-uniform taxes, states may seek waivers under a statistical test designed to ensure compliance.

How the Loophole Developed

CMS concluded that some states structured provider and MCO taxes in a way that technically passed the statistical test while undermining its purpose.

In practice, certain states:

• Imposed dramatically higher tax rates on Medicaid business than on comparable non-Medicaid business,
• Used those taxes to draw down enhanced federal matching funds,
• Repaid the taxed entities with federal dollars, and
• Retained surplus funds for state budget purposes, sometimes outside Medicaid.

CMS cited examples where Medicaid MCO taxes vastly exceeded comparable commercial taxes, yet still passed the existing statistical framework.

What the Final Rule Does

The final rule closes these pathways by reinforcing statutory guardrails and prohibiting structures CMS views as exploitative.

Key provisions include:

• Prohibiting higher tax rates on Medicaid business than on non-Medicaid business.
• Blocking vague, opaque, or indirect tax designs intended to disguise disproportionate burdens.
• Strengthening CMS enforcement authority over provider tax waivers.
• Implementing limits enacted by Congress in the Working Families Tax Cuts legislation.

The rule applies prospectively and also prevents new or increased provider taxes beyond authorized limits.

Transition Periods for States

Recognizing the budgetary impact, the final rule allows transition periods based on when a state’s tax waivers were approved:

• MCO taxes with waivers approved within two years of April 3, 2026
  • Transition through December 31, 2026
• MCO taxes with waivers approved earlier
  • Transition through the end of the state’s FY 2027
• Other permissible provider tax classes
  • Transition through the end of the state’s FY 2028

CMS emphasized that these timelines are intended to allow orderly restructuring while preventing continued exploitation.

Why This Matters for Providers and Plans

Although framed as a state financing issue, the rule has downstream implications for:

• Hospitals and health systems that benefited from state-directed payments,
• Medicaid MCOs subject to provider-specific taxes,
• Providers in states with aggressive provider tax structures, and
• Future Medicaid payment arrangements relying on supplemental funding.

States will need to identify alternative financing mechanisms, and providers should expect changes in Medicaid payment methodologies as these tax structures unwind.

Bottom Line

CMS has now finalized and begun enforcing a significant shift in Medicaid financing policy. States may no longer rely on provider tax arrangements that disproportionately burden Medicaid business while shifting costs to the federal government.

For providers and MCOs, the rule signals increased scrutiny of Medicaid financing arrangements and reinforces a broader trend toward tighter federal oversight of state Medicaid funding strategies.