CMS Shuts Down Massive Medicaid Tax Loophole, Saving Billions for Federal Taxpayers and Restoring the Federal-State Partnership
New Policy Delivers Major Program Integrity Win by Halting State Schemes that Previously Shifted Medicaid Costs onto Federal Taxpayers
The Centers for Medicare & Medicaid Services (CMS) is taking decisive action – through the Preserving Medicaid Funding for Vulnerable Populations—Closing a Health Care-Related Tax Loophole Final Rule – to implement and enforce statutory changes that closed a Medicaid financing gimmick. Over time, states have gradually shifted their Medicaid financing responsibility to federal taxpayers through gimmicks such as this. Today’s action is about states investing their fair share in the Medicaid program instead of taking advantage of federal taxpayers.
“We are bringing fairness, accountability, and integrity to Medicaid by restoring the Federal-State partnership,” said CMS Administrator Dr. Mehmet Oz. “Medicaid only works when every partner meets its obligations. States that have relied on loopholes to offload their responsibilities onto federal taxpayers undermined the law and directed additional Medicaid spending to favored providers instead of focusing on families who depend on this program. With this rule, CMS is ending these inappropriate schemes and ensuring every federal Medicaid dollar is used as Congress intended.”
For years, some states exploited healthcare–related tax structures to effectively push their share of Medicaid financing onto the federal government. From fiscal year 2012 to fiscal year 2024, the federal financing share of Medicaid increased from approximately 57 percent to 64.5 percent. [1] These schemes imposed higher tax rates on Medicaid Managed Care Organizations (MCOs) or other Medicaid providers while using the proceeds to obtain federal matching dollars, effectively repaying providers for their tax costs with federal funds and sometimes producing massive state windfalls at federal expense. This particular gimmick draws down more than $24 billion annually for state budget purposes, including to reward special interest providers. In one state alone, these arrangements generated more than $13 billion.
By shutting down these practices, the rule ensures federal taxpayer dollars are not siphoned inappropriately. In some cases, states used these financing gimmicks to support programs outside Medicaid’s scope. The Administration is making clear—federal Medicaid funds must only serve vulnerable Medicaid beneficiaries.
Key Provisions of the Final Rule
The rule firmly re-enforces guardrails Congress placed around healthcare-related taxes and ends state strategies designed to circumvent them.
- Prohibits states from imposing higher tax rates on Medicaid business than on non-Medicaid business, eliminating the core mechanism that fueled disproportionate revenue generation.
- Closes back-door pathways by blocking vague, opaque, or indirect tax structures intended to disguise disproportionate burdens on Medicaid business.
- Finalizes safeguards proposed in May 2025, strengthening CMS’ ability to enforce federal financing rules.
- Implements congressional direction in the Working Families Tax Cuts legislation (Public Law 119-21), reaffirming this Administration is executing clear statutory mandates.
- Establishes thoughtful transition timelines to give states an achievable path to compliance:
- For taxes on MCO services with waiver approvals within two years of April 3, 2026: Through the end of calendar year 2026
- For taxes on MCO services with waiver approvals two years or more before April 3, 2026: Through the end of the state’s FY 2027
- For taxes on other permissible classes: Through the end of the state’s FY 2028
These deadlines reflect extensive engagement with States and other stakeholders and balance the need for fiscal responsibility with the practical realities of redesigning tax structures. They also expand upon initial guidance provided by CMS regarding the transition authorized in statute.
Today’s action answers years of warnings from oversight bodies, economists, and advocates who sounded alarms about the unsustainable growth of these financing arrangements and the risks they posed to the integrity of the Medicaid program. This rule ensures federal resources remain focused on low-income children, families, older adults, people with disabilities, and all individuals who rely on Medicaid for essential healthcare.
CMS will work closely with states to support the implementation process and maintain open communication with Medicaid directors, provider associations, and managed care organizations to ensure compliance and minimize disruption, while also ensuring arrangements currently being developed by states and others to replace these schemes do not perpetuate these exploitative practices.
To review the final rule, please visit the Federal Register: https://www.federalregister.gov/d/2026-02040
To view the Fact Sheet: https://www.cms.gov/newsroom/fact-sheets/preserving-medicaid-funding-vulnerable-populations-closing-health-care-related-tax-loophole-final
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[1] See https://www.macpac.gov/wp-content/uploads/2021/11/The-Effect-of-State-Approaches-to-Medicaid-Financing-on-Federal-Medicaid-Spending.pdf and https://www.macpac.gov/wp-content/uploads/2025/08/Medicaid-Financing.pdf
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