On January 29, 2026, the Centers for Medicare & Medicaid Services (CMS) issued a final rule titled, “Preserving Medicaid Funding for Vulnerable Populations – Closing a Health Care-Related Tax Loophole Final Rule.” CMS also released a fact sheet and a press release accompanying the rule.

The rule is scheduled to published on the Federal Register on February 2, 2026, and will become effective on April 3, 2026.

Overview and finalized policies

In this final rule, CMS finalizes changes to the Medicaid health care-related tax regulations to clarify and strengthen the standards for determining whether a tax is “generally redistributive,” as required under section 1903(w) of the Social Security Act. The rule is intended to ensure that state health care-related taxes used to finance the non-Federal share of Medicaid do not disproportionately burden Medicaid providers or plans.

The rule prohibits higher tax rates on Medicaid businesses by addressing a mathematical loophole in the applicable statistical test which was designed to ensure that waiver approved non-uniform and non-broad-based health care-related taxes are generally redistributive. It also bars the use of vague language or complex design as an attempt to obfuscate the impact of the tax on Medicaid.  Finally, the rule incorporates statutory requirements of Public Law 119-21, enacted on July 4, 2025, which included provisions previously proposed in regulation and allowed for a transition period for states to bring existing tax structures into compliance with these requirements.

Key finalized policies include:

• CMS finalizes revisions to the regulatory framework used to assess whether a health care-related tax is generally redistributive. Under the final rule, a tax may not be treated as generally redistributive if Medicaid taxable units are subject to higher effective tax rates than non-Medicaid taxable units, even if the tax otherwise meets the existing statistical test in regulation.
• CMS finalizes regulatory updates to implement statutory language requiring that health care-related taxes not impose higher taxes on Medicaid providers or plans relative to non-Medicaid entities.
• Policy changes designed to prevent future improper shifting of the burden of financing the Medicaid program to the Federal government.
• Under the final rule, CMS will no longer approve new or renewed health care-related tax arrangements that meet the existing statistical test but fail to satisfy the clarified redistributive standard. States seeking waivers under section 1903(w) must demonstrate compliance with the revised criteria.

CMS states that these changes are intended to promote program integrity by ensuring that health care-related taxes reflect a genuine redistribution of tax burden and that federal Medicaid matching funds are paired with appropriate state financing responsibility.

Transition Periods and Compliance Timeframes

CMS acknowledges that some States will need to modify or discontinue certain existing health care-related taxes. To limit the impact of the rule to affected tax arrangements, CMS finalizes graduated transition periods to allow States time to come into compliance, while maintaining alignment with statutory requirements. Importantly, CMS provides additional flexibility than that provided its November 14, 2025 “Dear College Letter” subregulatory guidance, including in some cases more generous transition parameters and generally longer transition periods for hospital and other non- managed care organization (MCO) taxes.

Under the final rule, compliance dates are based on both the permissible class of tax and the most recent waiver approval date.

Managed Care Organization (MCO) taxes

• Waivers approved within two yearsof April 3, 2026 must comply by January 1, 2027.
• Waivers approved more than two yearsbefore April 3, 2026 must comply by the start of State Fiscal Year 2028.

Non-MCO taxes

• All non-MCO taxes affected by the rule must comply by the end of the State fiscal year ending in calendar year 2028(State Fiscal Year 2029).

CMS emphasizes that the transition period runs from the effective date of the final rule until the applicable compliance date. Revenues collected during an applicable transition period under an approved waiver will not be subject to disallowance based on the new requirements. After the transition period expires, CMS may deduct revenues from noncompliant health care-related taxes from medical assistance expenditures before calculating Federal Financial Participation (FFP).

State Flexibility and Compliance Options

CMS clarifies that States are not required to terminate affected taxes outright. States may instead modify tax structures to comply with federal requirements, including by making taxes uniform or otherwise adjusting rates to meet the generally redistributive standard. CMS notes that modified taxes must still comply with all other statutory and regulatory requirements, including hold-harmless provisions, and that approval of amended waivers is not automatic.

CMS states that the rule is not intended to reduce States’ overall taxing authority or ability to generate revenue, and that States may be able to maintain similar revenue levels through compliant tax structures. CMS also indicates it will continue to provide technical assistance to affected States as they implement the finalized policies.

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This Applied Policy® Summary was prepared by Meghan Basler with support from the Applied Policy team of health policy experts. If you have any questions or need more information, please contact her at mbasler@appliedpolicy.com or at 908-752-9875.