The Centers for Medicare and Medicaid Services (CMS) have finalized a new rule tightening standards for approving certain Medicaid provider tax waivers, with particular focus on Managed Care Organization (MCO) taxes. CMS says certain states are “exploiting loopholes” by drawing down additional match funds without a proportional state contribution, and using those funds for other activities like imposing higher taxes on Medicaid MCOs or “health care coverage for undocumented immigrants.” CMS sent letters to states like California, Illinois, Michigan and New York regarding these concerns. The Agency estimates the final rule will reduce Medicaid spending by over $78 billion in the next 10 years. 

The final rule closes the “loophole” by adding additional safeguards, beyond the existing statistical tests, so that a tax waiver that “passes” the math test can still be found non-approvable. This would happen if the waiver has characteristics inconsistent with being “generally redistributive.” CMS may find a tax not “generally redistributive” if, for example: 

  • The tax rate imposed based on Medicaid taxable units is higher than the tax rate from non-Medicaid taxable units, with limited exceptions. 
  • The state uses explicit (or effectively explicit) structuring so that entities with higher Medicaid taxable units face higher rates than those with lower Medicaid taxable units.  
  • CMS also will be increasing its vigilance around the use of vague language or complex design intended to disguise targeting of Medicaid.  

The final rule is effective April 3, 2026, with transition time allowed in certain circumstances. Recently approved MCO taxes (approved within two years of April 3, 2026) must comply by January 1, 2027. Waivers approved more than two years before April 3, 2026, must comply by the start of state Fiscal Year 2028. Some non-MCO taxes will be allowed to transition through the end of the state’s fiscal year 2028.  

CMS clarified that states aren’t required to terminate affected taxes outright. States may instead modify tax structures to comply with federal requirements.