The Centers for Medicare and Medicaid Services (CMS) on July 21, 2026, published a notice of proposed rulemaking,  Medicaid Program; Amending the Indirect Hold Harmless Threshold of Health Care Related Taxes (CMS-2452-P), which provides a framework to implement HR 1’s section 71115. This addresses prohibitions on new taxes and caps on existing taxes, and the phasedown of applicable taxes in expansion states. It also proposes more robust compliance criteria and state reporting requirements. The proposed rule adds new definitions and classifications that impact how states can collect taxes, including a newly applicable taxable class.

CMS anticipates implementation of the rule, as proposed, would reduce federal Medicaid spending by $246 billion from 2026-2035.

States use healthcare, also called provider, taxes as they use other taxes: to generate revenues. These revenues are then generally used to fund a portion of the state share of Medicaid spending, allowing for federal matching funds to further augment provider rates or offset other programmatic costs.

HR 1 included three provider tax restrictions: 1) a prohibition on new provider taxes and increases in existing taxes; 2) in Medicaid expansion states, a phasedown of the permissible size of certain provider taxes; and 3) a prohibition on certain waivers of uniformity. LeadingAge commented on the changes to the waivers of uniformity and CMS finalized a rule around this policy in January 2026.

HR 1 caps existing taxes by limiting states from increasing their tax in the future above the enacted levels or imposing new taxes that were not enacted as of July 4, 2025. The rule does not change the hold harmless thresholds on nursing homes or intermediate care facilities, leaving those taxes mostly unscathed, in alignment with the statute. For all other provider taxes in Medicaid Expansion states, reductions in total collectible revenues will begin to decrease in the coming years to bring states into compliance with a 3.5% of net patient revenues hold harmless cap on other taxed classes by 2032. The proposed rule will be open for comment for 60 days, close on September 21. The public posting of the rule is available here and the CMS fact sheet is here.

Changes to the Indirect Hold Harmless Test and Thresholds

The indirect hold harmless test uses net patient revenues as a denominator in calculating compliance with the legacy 6% threshold. CMS established 6% as the taxable threshold as it aligned with averages of other taxes imposed on goods and services in states. HR 1 phases down that threshold in Medicaid Expansion states to 3.5% by 2032, limiting the total revenues states can collect through these taxes. The phasedown does not apply to taxes imposed on nursing homes or intermediate care facilities. Because of the new statutory phasedown, CMS is proposing to codify their methodology for calculation, which they indicate remains the same, but was not previously in regulation. The change establishes that CMS will allow rounding, to 9 decimal places in establishing both baseline imposed tax percentages, and ongoing compliance with the phasedown.

Additionally, HR 1 makes no mention of the second prong of the hold harmless test, used to assess taxes that exceed the 6% threshold, generally referred to as the 75/75 test. For a tax to pass this prong requires that no more than 75% of taxpayers receive 75% or more of their assessed tax. A tax that both exceeds the 6% test and fails the 75/75 test constitutes an improper and non-compliant tax. The rule proposes to eliminate the 75/75 test as of October 1, 2026.  Though established in 1992, only one permissible tax has ever been approved using this methodology, therefore the prospective elimination will have negligible impact though will limit states flexibility in using the test in the future for taxes that may exceed new hold harmless thresholds.

Hold Harmless Threshold Reduction Timing

CMS proposes that the newly implemented phasedown caps apply to federal fiscal years, not aligning with state fiscal years (SFY). This proposal will increase administrative complexity for states, as their tax structures, rates, and renewals typically correspond to SFY. This will require compliance calculations to span separate rate and revenue collection periods by states, further increasing opportunity for error.

If in the future a state that has not yet expanded Medicaid decides to do so, the new indirect hold harmless thresholds will be applicable to that state based on the phase-down schedule. For example, a state expanding Medicaid in 2033 would be subject to 3.5% hold harmless thresholds on eligible provider classes, regardless of the enacted tax levels as of July 4, 2025.

New Provider Class: Health Insurers; Separate from HMOs and PPOs

The rule defines a new class of limited taxes- those on health insurers. CMS identified multiple states imposing taxes on health insurance services, that were not previously reviewed by CMS for compliance with healthcare taxes. This new class includes taxes on insurers other than HMOs and PPOs (which are already covered as a provider class under 42 CFR 433.56(a)(8) services of managed care organizations) not previously known to CMS, and in most instances imposed by a state’s insurance department. These taxes are often assessed on private insurance and used to fund state-based marketplaces or premium subsidies, to supplement federal premium tax credits established by the Affordable Care Act. Though HR 1 doesn’t contemplate tax classes established after the law passed, CMS is proposing to subject taxes on these classes to the same requirements of other provider taxes, including the tests for generally redistributive principles and the newly proposed state reporting and indirect hold harmless threshold reductions. CMS’ statutory authority to do this is unclear. CMS fails to include information on the number or scope of these taxes or analysis of which taxes may not meet the newly imposed regulatory framework. CMS also decided not to provide any additional structure or direction of how states with existing taxes on this class that fail any of CMS healthcare tax tests or requirements would come into compliance. CMS does propose that the hold harmless threshold phasedown will apply to taxes on this new class, and on the same timeline as other phase downs.

CMS Clarifies “Enacted” and “Imposed”

The rule proposes to slightly revise CMS guidance to states from November 14, 2025 to include more clarity around the waiver approval process, and how states should address legislation that creates or amends taxes retrospectively to a date prior to the July 4, 2025 compliance date for ‘enacted’ taxes.

Compliance with enacted and imposed taxes requires CMS to establish a state baseline for the tax that was both enacted and imposed on July 4, 2025. To do this, CMS is requiring states to use one year of data, based on the state fiscal year (SFY) that includes July 4, 2025. This approach makes the most administrative sense for states and should establish data based on a singular tax rate and structure, mitigating additional burden on states that could have been imposed if CMS established different timing such as federal fiscal year, or other more arbitrary definitions for states. That said, this data could stretch well before July 4, 2025, depending upon a state’s established fiscal year timing.

The timing of CMS interpretation of imposed is welcome. CMS has deferred the requirement of an approved waiver from the ‘enacted’ definition to the ‘imposed’ definition, meaning states would need to have an approved waiver as of July 4, 2025 to consider the tax imposed. We applaud the additional two months and CMS’ consideration of longstanding policy and regulatory obligation to retroactively approve waivers to the first day of the quarter in which the waiver was submitted to CMS. The preamble notes, “Upon further analysis and based on CMS’ longstanding application of § 433.72(c), which provides that a waiver will be effective beginning on the first day of the calendar quarter in which the waiver request is received by CMS, we determined that this revised interpretation more appropriately reflects CMS and State practices regarding waiver requests and effective dates.” This timing and flexibility reflect both the regulatory obligation of CMS and the longstanding practice to which states have been accustomed. State waiver submitted to CMS prior to October 1, 2025 should be approved back to July 1 and constitute an ‘imposed’ tax.

State compliance with ongoing compliance reporting could become challenging. States will be required to report data based on federal fiscal years, which for many states will span multiple tax rates and structures. This will add administrative burden for states and introduce unnecessary complexity. Additionally, CMS estimates a nominal cost to states to complete this reporting, assuming the data is being pulled by a clerical state worker. This fails to account for many levels of review to assess data integrity and outside consulting support, relied upon heavily by many states for their provider tax programs.

Federal Match for Impermissible Taxes

For provider classes taxed multiple ways, such as by a state and a locality, CMS reminds states of the scope of the hold harmless threshold calculation. All applicable taxes on a permissible class are to be included in the hold harmless calculation. If CMS establishes that taxes on a specific class have exceeded the hold harmless threshold, CMS will deduct ALL revenues from ALL taxes on that class when establishing their federal share of related expenditures. For example, if a hold harmless threshold was established at 5%, but the state and local governments combine for taxation at 5.5% of net patient revenues, CMS will not financially match ANY revenues generated from that tax. If the tax totaled $55 million in revenues, where $50 million would have met the applicable threshold, CMS will not match any of the $55 million, though only $5 million in collections exceeded the threshold.

Regulatory Impact Analysis

CMS acknowledges that the rule will have a significant impact on state Medicaid funding and spending. In considering the rule’s effect, CMS says, “As States often use provider taxes to finance Medicaid spending, we expect that reductions in provider tax revenues would lead to lower Medicaid benefit expenditures. This reduced spending could result in reductions in payments to providers, services covered, and enrollment.” They go on, “we believe that States would be more likely to prioritize covering enrollees above maintaining provider payment rates and benefits offered in response to this proposed rule.” In short, CMS anticipates that states will reduce provider rates in response to reduced revenues from provider taxes. Their impact analysis goes on to discuss the intersection of this rule with limitations previously proposed in the state directed payment rule (SDP Rule) and notes there are overlapping impacts. Revenues generated by provider taxes (limited in this rule) are used by states to fund targeted supplemental payments in the SDP Rule (our comments on the SDP rule).

Conclusion

LeadingAge will be submitting comments on the rule and look forward to engaging with members and state partners on how best to mitigate the impacts of this rule on states and members.