Today, CMS published a proposed rule titled “Medicaid Program; Amending the Indirect Hold Harmless Threshold of Health Care Related Taxes” (Proposed Rule). The Proposed Rule would largely implement new “indirect hold harmless” requirements and codify statutory limits established with respect to health care-related taxes (commonly known as provider taxes) by Section 71115 of the One Big Beautiful Bill Act, Public Law 119-21 (OBBBA, or what CMS calls the Working Families Tax Cut (WFTC) legislation). The Proposed Rule follows on the November 14, 2025, Dear Colleague Letter (November 2025 Guidance) outlining “preliminary” guidance on Section 71115 of the WFTC.
The Proposed Rule, including several key differences between the November 2025 Guidance and the Proposed Rule, are discussed below. Comments on the Proposed Rule are due September 21, 2026.
Background
For decades, provider taxes have served as a critical mechanism for states to generate revenue that can be used to pay the non-federal share of Medicaid expenditures, which is necessary because of the joint funding of Medicaid by the states and the federal government. According to federal law, while at least 40 percent of each state’s funding for the non-federal share must derive from state general revenues, up to 60 percent may come from other permissible sources. Today, 49 states and the District of Columbia impose at least one provider tax and those revenues collectively fund roughly a quarter of all state Medicaid expenditures.
As part of the OBBBA, Congress created new limitations on states’ use of provider taxes to fund the non-federal share of their Medicaid programs. Section 71115 of the WFTC established a new indirect hold harmless threshold for provider taxes, effective “for fiscal years beginning on or after October 1, 2026.” Per Section 1903(w) of the Social Security Act (SSA), provider taxes must be imposed on a permissible class of health care items or services, be broad-based (generally applying to all non-Federal, non-public providers within the permissible class) and be uniform (generally applying at the same tax rate for all taxed providers). The statute also prohibits direct and indirect hold harmless arrangements that guarantee to hold taxpayers harmless. Relevant here, CMS has created and Congress has effectively ratified, a rule that establishes that there is no “indirect guarantee” to the extent provider taxes for a particular class of health care items or services are below a specified percentage of net patient revenues. Since 2011, that percentage, also known as the “indirect hold harmless threshold,” has been 6 percent. In effect, the indirect hold harmless threshold has largely limited the scope of provider taxes, for each class of permissible health care items or services, to the specified threshold. If the indirect hold harmless threshold is not met, there is a second test, called the 75/75 test, that could theoretically be met, but as a practical matter rarely is.
Section 71115 establishes new indirect hold harmless thresholds, effective for “fiscal years beginning on or after October 1, 2026,” for provider taxes on each permissible class of health care items or services, based on the level of taxes that a government has “enacted” and “imposes” on that class of health care items or services as of July 4, 2025. If a state had not enacted or imposed a provider tax on a particular class of health care items or services as of July 4, 2025, the state is effectively barred from enacting a new provider tax on that class of health care items or services (since the indirect hold harmless threshold for that class of health care items or services is set at zero percent).
Provider taxes in states that expanded Medicaid to include the new eligibility category created by the Affordable Care Act (and made optional by the US Supreme Court in National Federation of Independent Business v. Sebelius in 2012) (i.e., Medicaid expansion states) must additionally comply with an indirect hold harmless threshold that is the lower of the revised indirect hold harmless threshold or a specified percentage that steps down from 6 percent by 0.5 percent per year beginning in fiscal year 2028 until the maximum allowed percentage is reduced to 3.5 percent in fiscal year 2032.
Key Provisions of the Proposed Rule
- The Revised Indirect Hold Harmless Threshold Calculation: The Proposed Rule replaces the current two prong test used by CMS to determine the absence of an indirect guarantee under the provider tax hold harmless provisions with an “applicable percent” initially fixed for federal fiscal year (FFY) 2027 at the level of net patient revenue attributable to taxes that a state had both enacted and imposed as of July 4, 2025. This calculation is statewide and spetwcific to each permissible class of health care items and services. CMS announces in the Proposed Rule that all OBBBA references to “fiscal year” pertain to the federal fiscal year.
As discussed above, Medicaid expansion states face a further multi-year phase-down of that threshold beginning in FFY 2028, requiring those states to reduce provider tax rates that exceed the threshold.
- Revised Interpretation of “Enacted” and “Imposed”: The Proposed Rule interpretations of “enacted” and “imposed” notably diverge from the November 2025 Guidance. CMS’s prior interpretation of “enacted” required a state (or unit of local government) to not only have completed the entire legislative process necessary to authorize the tax (including the process necessary to amend an existing tax, regardless of the state’s normal regulatory cadence), but also to have received CMS approval for any waiver of the broad-based or uniformity requirements related to the tax as of July 4, 2025. In addition, the agency’s prior interpretation of “imposed” required that the state was “actively collecting revenue” on the tax and seemed to suggest that CMS would only credit a state’s provider tax rate based on the revenue collected pursuant to the tax as of July 4, 2025. The Proposed Rule notably revises these interpretations of “enacted” and “imposed” in a way that provides additional flexibility to states and CMS.
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 the OBBBA.
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 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.
- Discontinuation of the 75/75 Test: Beginning on or after October 1, 2026, CMS proposes to eliminate a secondary “hold harmless” test known as the 75/75 test, leaving the new class-specific threshold as the sole indirect “hold harmless” test. CMS reasons that continuing the 75/75 test could permit states to circumvent the new statutory limits, a concern HHS-OIG had previously flagged in 2018 and notes the 75/75 test has been satisfied by only one tax in its history. States with a CMS-approved threshold above 6% under the 75/75 test as of July 4, 2025 may retain that higher tax rate (subject to the required statutory phasedown for Medicaid expansion states).
- New Permissible Class for Health Insurers: CMS proposes adding a new permissible class for “services of health insurers,” which are distinct from managed care organization (MCO) services that are already a permissible class of taxable entities. Many states currently impose health care-related taxes on health insurers, such as taxes on health insurance premiums, without a clear permissible-class basis under SSA Section 1903(w). This new class would be subject to the same threshold and phase-down framework, with an applicable threshold percentage of zero for taxes not enacted and imposed by July 4, 2025.
- Enhanced Reporting Requirements: The Proposed Rule would impose significant new reporting obligations. States would be required to submit one-time interim reporting, covering 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. One-time final reporting using actual data would be due by June 30, 2028. New quarterly ongoing reporting requirements would begin October 1, 2026, including data on tax amounts collected, use of tax revenue and whether public providers are exempted (to help CMS detect potential “hold harmless” arrangements involving intergovernmental transfers).
Next Steps
Given the magnitude of the estimated fiscal impact of the Proposed Rule – a $245.8 billion reduction in federal Medicaid spending over 2026-2035 – and the compressed timeline, stakeholders should immediately begin preparing comments before the September 21, 2026 comment deadline for the Proposed Rule.
States may wish to prioritize compiling necessary tax collection and net patient revenue data now, given the December 31, 2026 interim reporting deadline. Providers should assess how the revised indirect hold harmless calculation and expansion state phase-down will affect their individual tax burdens and anticipated Medicaid payment levels, particularly in light of the companion State Directed Payments rule, which we summarized previously and will likely be finalized this fall.
