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February 12, 2026 – Over the past few years, scrutiny of Medicaid “provider taxes” has increased, largely because of concerns that they may inflate federal spending in the Medicaid program. Under federal law, states are allowed to levy taxes on their providers, including hospitals, nursing facilities, and managed care organizations (MCOs), to generate the state share of Medicaid expenditures and draw down federal matching funds. The One Big Beautiful Bill Act (OBBBA), signed into law in July 2025, enacted two Medicaid provider tax provisions (Sections 71115 and 71117). In May 2025, while Congress was debating OBBBA, the Centers for Medicare & Medicaid Services (CMS) issued a proposed rule that largely mirrored Section 71117; however, it included a different transition period for affected provider taxes. Just two weeks ago, CMS issued the final rule. The final rule largely reflects the OBBBA and the proposed rule, with a key distinction related to state transition periods. To help me break down this rule, the implications for affected states, and what is to come in Medicaid provider tax policy, I’m bringing in my colleagues Katie Waldo and Maddie News.
Certain existing federal requirements regulate the size and scope of provider taxes. A provider tax must be “uniform and broad based.” Within the context of MCOs, this means that the tax must be applied at the same level and to all MCOs in the state, not just MCOs that serve the Medicaid population. However, a state can apply to CMS to waive the broad-based and uniform requirements if the tax’s net impact is generally redistributive and the tax amount is not directly correlated to Medicaid payments. To receive a waiver, states must conduct a statistical test to prove that the tax meets the exemption criteria. Some stakeholders have expressed concerns about this statistical test for several years. The first Trump administration issued a proposed rule aiming to address issues with the test in May 2019, but it was never finalized. In the waiver approval letters for California and New York, the Biden administration stated that CMS would soon propose new regulatory requirements to address concerns about the test.
Section 71117 of OBBBA and CMS’s recent final rule aim to close what CMS refers to as a “loophole” in the statistical test: a perceived ability for states to pass the test despite the provider taxes not being generally redistributive. CMS argues that by circumventing the test, states can create a tax that burdens non-Medicaid MCOs less, allowing Medicaid MCOs to be “made whole” through increased Medicaid payments. CMS notes in the final rule that one current tax, despite passing the statistical test, applies to Medicaid MCOs at a rate that is 117 times higher than the rate for non-Medicaid MCOs.
In the rule, CMS aims to eliminate the loophole by prohibiting states from taxing Medicaid services or businesses, such as Medicaid MCOs, at a higher rate than non-Medicaid services or businesses, such as non-Medicaid MCOs. CMS notes that seven states (understood to be California, Illinois, Massachusetts, Michigan, New York, Ohio, and West Virginia) currently have a waiver for their MCO tax and will need to “come into compliance” with the new policy (we explain more about timeline and options for coming into compliance below). There are two additional tax waivers (one hospital tax and one nursing facility tax, for a total of nine waivers) in those seven states that also need to come into compliance.
While the May 2025 proposed rule would have required certain states to come into compliance immediately, CMS issued preliminary guidance in November 2025 stating that all states would have a transition period for their waivers to come into compliance. Most of the transition periods provided in the final rule are longer than indicated in the November guidance. The final transition periods vary by provider class and the approval date of a state’s most recent MCO tax waiver.
| Tax class | Most recent waiver approval | Final rule compliance deadline |
|---|---|---|
| MCOs | Within two years of April 3, 2026 | January 1, 2027 |
| MCOs | More than two years from April 3, 2026 | The start of state fiscal year (SFY) 2028 |
| All other provider classes | Any approval date | The start of SFY 2029, but no later than October 1, 2028 |
States are allowed to take different approaches to comply with the policy. One option is for states to reduce the tax rates on Medicaid MCOs, thereby reducing the revenue generated and reducing the federal match states can receive. States could also halt their MCO tax altogether. Regardless of the approach taken, affected states may experience budget gaps that they would need to fill either by raising revenues from another source or by restricting services or benefits to reduce overall spending.
New York and California will have to comply by January 1, 2027, because their most recent MCO tax waivers were approved within two years of April 2026. Both states’ MCO taxes are major sources of funding for their Medicaid programs. New York’s MCO tax is projected to net $3.7 billion in state savings in SFY 2026. The revenue contributes to the state’s healthcare stability fund and is earmarked for investments such as increased payment rates for hospitals and nursing homes, safety net transformation, and quality pools. The state’s enacted financial plan explicitly notes that absent continued federal approval of the MCO tax, the plan does not include funding for these investments beyond SFY 2028.
The approximated net annual revenue for California’s MCO tax is $7.5 billion. In November 2024, California residents approved Proposition 35, which makes the MCO tax permanent under state law. It directs the state to use the revenue to increase provider payment rates and invest in health workforce initiatives starting in 2025, and even specifies which provider types should receive payment increases over time. CMS’s final rule will doubly impact California because the state also operates a waiver for its hospital tax. While California has until the start of SFY 2029 to bring that waiver into compliance, the hospital tax currently generates more than $5 billion in net annual revenue.
It is not clear yet how the seven affected states will comply and how this will affect their Medicaid programs. Nevertheless, the states will need to reassess how their Medicaid programs are financed and decide how to proceed – potentially making consequential decisions about what benefits and services to prioritize.
As noted, OBBBA includes two provider tax provisions. The second (Section 71115) is broader and affects all states’ provider taxes, including those impacted by Section 71117 and the CMS final rule. Under current federal regulations, Medicaid provider taxes must be broad based and uniform but also must hold taxpayers “harmless,” which means providers are not guaranteed to be repaid the taxes they contribute. “Hold harmless” arrangements are permissible if the taxes remain below 6% of net patient revenue.
Section 71115 of OBBBA prohibits states from increasing or enacting new Medicaid provider taxes. Starting in fiscal year 2028, states that expanded their Medicaid populations under the Affordable Care Act are required to lower the 6% hold harmless threshold by 0.5% per year, until the threshold is 3.5% in 2032, effectively reducing tax rates below the new threshold. (This reduction does not apply to provider taxes on nursing facilities or intermediate care facilities.) CMS states that the final rule does not conflict with Section 71115 because Section 71115 does not prevent modifications to provider taxes.
According to KFF, the MCO taxes in California and Illinois and the hospital tax in California are currently above 3.5% of net patient revenue. Therefore, if those states opt to retain their taxes affected by the final rule beyond the transition period, they will need to eventually and gradually reduce the tax rate until they are at 3.5% in 2032.
That’s a lot to digest, but there is more regulatory activity coming. A proposed rule, Amending the Indirect Hold Harmless Threshold of Health Care-Related Taxes, is pending Office of Management and Budget review and is expected to address OBBBA Section 71115. We will be tracking that proposed rule and how states respond to this recently released final rule and the OBBBA policies in the coming years. In the meantime, please reach out with questions!
Until next week, this is Jeffrey (and Katie and Maddie) saying, enjoy reading regs with your eggs.
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