backCMS Proposes Limits on Provider Taxes, Likely Leading to Reductions in Medicaid Payments
On July 23, 2026, CMS proposed a rule that would significantly restrict how states use provider taxes to fund their Medicaid programs. For expansion states, the rule would cut the allowable tax threshold nearly in half from 6% to 3.5% of net patient revenue over a series of years. Non-expansion states would be frozen at their current rates, and no state could enact new provider taxes going forward. The proposed rule implements the One Big Beautiful Bill Act, formally known as the Working Families Tax Cut legislation (WFTC), and could force states to either reduce Medicaid payments to providers or backfill lost revenue from other sources.
Health care-related provider taxes are assessments that states impose on hospitals, nursing facilities, and other providers. These taxes have historically served as a financing tool for state Medicaid programs, allowing states to generate the non-federal share needed to draw down federal matching funds and sustain payments to the providers that serve Medicaid patients. Under existing rules, these taxes are permissible so long as they are broad-based, uniformly imposed, and fall below the 6% of net patient revenue safe harbor threshold. Section 71115 of the WFTC legislation directed CMS to sharply curtail this longstanding financing mechanism, phasing the threshold down to 3.5% for Medicaid expansion states, freezing existing rates for non-expansion states, and eliminating the safe harbor entirely for any new taxes enacted after July 4, 2025.
New Provider Tax Thresholds Replace Historical 6% Safe Harbor
Under the proposed rule, the existing uniform 6% safe harbor would be replaced by a state-specific threshold tied to each state’s actual tax rate as of July 4, 2025, the date the One Big Beautiful Bill was signed into law. For each “permissible class” of providers (e.g., hospitals, nursing facilities), a state’s baseline threshold would be set at whatever rate it had “enacted” and “imposed” on that date. If a state had no tax in place for a particular provider class by July 4, 2025, the threshold for that class would be zero. CMS also proposes that post-July 4, 2025 tax increases would not count toward the baseline threshold calculation.
A key question for states and providers is whether their existing taxes qualify for a calculated threshold. CMS would treat a tax as “enacted” based on whether the state or locality enacted the tax by July 4, 2025, and would treat a tax as “imposed” where taxpayers were subject to a legally enforceable obligation to pay the tax as of that date. For expansion states, beginning in federal fiscal year (FFY) 2028, the indirect hold harmless threshold would be subject to a statutory phase down, starting at 5.5% in FFY 2028 and decreasing by 0.5 percentage points annually until reaching 3.5% in FFY 2032. The applicable threshold for each permissible class in an expansion state would be the lower of the July 4, 2025, calculated threshold or the phased-down applicable percentage for that FFY.
New Class Subject to Phase Down
In addition to restricting existing provider tax programs, the proposed rule would create a new category of taxable entities. CMS proposes to add services of health insurers as a new permissible class of health care items or services, excluding managed care organizations (MCOs), which are already addressed in an existing permissible class. According to CMS, the proposed class could encompass group and individual market health insurance, short-term limited-duration insurance, excepted benefits, certain Medicare-related premium revenue, and section 1115 premium assistance contexts. Health insurer taxes that were enacted and imposed by July 4, 2025 would receive a threshold calculation under the new framework; those not enacted and imposed by that date would have a zero percent threshold. The expansion-State phase-down rules would also apply to this new class.
Elimination of the 75/75 Test and New Reporting Requirements
The proposed rule would also change how CMS evaluates whether a tax arrangement crosses the line into an impermissible “hold harmless” arrangement. Under the current framework, CMS uses a two-part test to determine whether a provider tax impermissibly holds providers harmless: the first prong checks whether the tax exceeds the safe harbor threshold as a percentage of net patient revenue, and the second, known as the “75/75 test,” asks whether 75% or more of the taxpayers receive back 75% or more of their tax costs through Medicaid payments or benefits. CMS proposes to sunset the secondary prong (the “75/75 test”) of the existing indirect hold harmless determination to ensure that the thresholds calculated as of July 4, 2025 serve as the maximum permissible level.
CMS further proposes enhanced reporting requirements, including one-time interim reporting by December 31, 2026, final threshold reporting by June 30, 2028, and quarterly enhanced reporting beginning with FFY 2027. CMS states that it may reduce future grant awards, impose deferrals or disallowances, or withhold approval of state payment proposals where a state fails to comply with reporting requirements.
Comment Period Ends in September 2026
Comments on the proposed rule are due by September 21, 2026. Given the sweeping implications for hospital and provider reimbursement, particularly in expansion states where provider taxes underpin both supplemental payment programs and expansion population coverage, stakeholders should consider submitting comments addressing the operational and financial impact of the proposed thresholds.
The proposed rule can be found on the Federal Register website here.
Reporter, Brittany Tandy, Austin, TX, +1 512 457 2071, btandy@kslaw.com
CMS Scrutinizes AMA’s CPT® Coding System, Seeks Public Input
On July 16, CMS published a significant Request for Information (RFI) to assess potential reforms to overhaul the American Medical Association’s (AMA’s) Current Procedural Terminology® (CPT®) coding system. The RFI was included in the Calendar Year (CY) 2027 Physician Fee Schedule Proposed Rule (CMS-1848-P).
Concerns about Conflicts, Patient Care, and Innovation
The RFI cites “longstanding concerns” raised by the Medicare Payment Advisory Commission (MedPAC) about over-reliance on a private organization with a financial interest in the CPT® and Relative Value Scale Update Committee (RUC) processes. CMS also suggests the processes may contribute to a “‘sick care’ system with limited emphasis on prevention and … inhibit progress on the Secretarial priority to Make America Healthy Again.”
CMS requests input on the “harms or challenges associated with AMA’s monopoly” as well as “potential improvements to patient care diverted or delayed … including inhibited innovations and acquisition/maintenance costs of CPT® licensure.” Notably, CMS also asks whether any alternatives to the CPT® and RUC processes exist or could be developed and adopted to maintain a more objective process, while considering the impact on innovation.
Alternative Coding Systems
CMS specifically seeks comments on the possible “benefits and drawbacks of paying for physician procedural services on the basis of the underlying International Classification of Diseases, 10th Revision (ICD-10) procedure code, as an alternative,” with services grouped or bundled into payment categories similar to other Medicare payment systems. The agency notes that a combination of CPT® and the Healthcare Common Procedure Coding System (HCPCS) codes were adopted through rulemaking as the current national coding standard and questions the need for additional rulemaking and a separate legal standard.
Congressional Focus on Costs and Improper Billing
The agency’s inquiry comes in the wake of congressional investigations launched by the Senate Health, Education, Labor, and Pensions (HELP) Committee and the House Committee on Oversight and Government Reform (OGR). The Senate HELP Committee has focused on how the current CPT® “monopoly” may increase costs within the healthcare system based on revenues generated through licensure and sales of ancillary services and materials. The House OGR Committee has questioned the complexity of CPT® coding and noted the potential for the system to be gamed through improper billing, upcoding, or other abuses.
What's at Stake
Providers, manufacturers, and other stakeholders should recognize the potential for CPT® reform to cause major upheaval in the healthcare sector. Risks include incomplete and inaccurate federal data systems, bias toward bundled and packaged payments, and federally driven rate-setting, among others. Given the broad scope of the RFI, the potential impact of sweeping changes to the CPT® coding system, and related congressional interest, stakeholders should seriously consider taking this opportunity to inform CMS policy deliberations. The deadline for comments on the RFI and the Proposed Rule is September 14, 2026.
Reporter, Todd Tuten, Washington, DC, +1 202 626 3731, ttuten@kslaw.com
D.C. Circuit Affirms HHS Authority to Block Drugmakers’ 340B Rebate Plans, Requiring Pre-Approval Before Implementation
On July 21, 2026, the U.S. Court of Appeals for the District of Columbia Circuit upheld a lower court’s determination that HHS has the authority to block or approve pharmaceutical manufacturers’ efforts to implement rebate mechanisms instead of discounts under the 340B Drug Pricing Program. The opinion affirms that the HHS Secretary must affirmatively approve rebate models before manufacturers may implement them, resolving consolidated appeals brought by four drug manufacturers.
The 340B Program
The 340B Drug Pricing Program requires drug manufacturers to provide outpatient drugs to covered entities at a discount as a condition of having those drugs covered by Medicaid and Medicare Part B. Historically, manufacturers have satisfied their obligations through upfront discounts. In recent years, however, several drug manufacturers sought to replace upfront discounts with rebate models under which covered entities would pay full price at the time of purchase and receive reimbursement after the fact. These proposals drew opposition from hospital associations and other covered entities, which argued that delayed reimbursement would impose financial burdens on providers serving vulnerable populations.
Procedural Background
The four drug manufacturers (and a technology company with which one manufacturer contracted to develop a digital platform to implement its proposed model) sued the HHS Secretary in D.C. federal court under the Administrative Procedure Act, stating that HRSA exceeded its authority by requiring pre-approval for rebates. A 340B advocacy organization and two hospitals intervened as defendants. In May 2025, Judge Dabney L. Friedrich of the U.S. District Court for the District of Columbia largely sided with the government, holding that HRSA did not exceed its authority by requiring pre-approval of the rebate proposals. The cases were consolidated on appeal and argued before the D.C. Circuit on November 17, 2025.
The D.C. Circuit Court’s Decision
Rebates Are Not Categorically Prohibited
As a threshold matter, the panel rejected the intervenors’ argument that Section 340B categorically bars rebate mechanisms and requires only upfront discounts. The court explained that the statute expressly contemplates rebates, and that the ordinary meaning of “rebate” encompasses the manufacturers’ proposed refund-based models.
The Secretary Must Pre-Approve Rebate Models
However, the court held that Section 340B requires the Secretary to affirmatively provide for a rebate mechanism before manufacturers may implement one. The panel focused on the key statutory provision, requiring “[t]he Secretary to enter into agreements” with manufacturers “under which the amount required to be paid (taking into account any rebate or discount as provided by the Secretary)…does not exceed the ceiling price.” The court interpreted the phrase “as provided by the Secretary” to mean that the Secretary must supply or make available the relevant mechanisms before manufacturers may impose rebates.
The court further reasoned that the manufacturers’ reading would counterintuitively place manufacturers rather than the Secretary in the lead role of administering the 340B Program, rendering the Secretary’s function largely reactive.
The Pre-Approval Requirement Is Not Limited to the Pricing Agreements
The manufacturers also argued that if the Secretary wanted to restrict rebate models, he needed to say so in the Pharmaceutical Pricing Agreements that each manufacturer signs with HHS. The drug manufacturers contended that because those Pharmaceutical Pricing Agreements are silent on rebates, the Secretary had no basis to block their proposals. The court disagreed, reasoning that the Pharmaceutical Pricing Agreements are standardized government forms with no negotiable terms and they are not the only place the Secretary can exercise authority over pricing mechanisms. Congress could have made the Pharmaceutical Pricing Agreements the exclusive vehicle for such decisions but chose not to.
Arbitrary-and-Capricious Challenge Fails
Finally, the manufacturers argued that even if the Secretary has pre-approval authority, it was unreasonable for him to invoke it now after never having done so before. The court was unpersuaded. Because the pre-approval requirement comes directly from the statute rather than from a discretionary agency policy choice, the Secretary did not need to justify a change in approach. The court also found it premature to evaluate whether the Secretary adequately considered the merits of the manufacturers’ rebate proposals, since HHS has not yet issued a final decision approving or rejecting them; the review remains ongoing.
Key Takeaways
The D.C. Circuit’s decision carries several significant implications for stakeholders in the pharmaceutical and healthcare sectors. First, the ruling establishes that the HHS Secretary, not individual manufacturers, controls the terms under which rebate mechanisms may operate within the 340B Program. Second, the decision leaves the door open for HHS-approved rebate models. Third, covered entities and hospital associations that depend on 340B pricing will benefit from the status quo requiring upfront discounts absent secretarial authorization of an alternative mechanism.
Lastly, rebates have been an ongoing discussion. In July 2025, HRSA invited manufacturers to join a voluntary rebate-model pilot, withdrew that notice in February 2026 after separate litigation, and announced in June 2026 that it plans to issue a revised pilot with implementation criteria through a Federal Register notice.
The U.S. Court of Appeals for the District of Columbia Circuit decision can be found here.
Reporter, Priya Sinha, Atlanta, GA, +1 404 572 3548, psinha@kslaw.com
CMS Pauses $1 Billion in Medicaid Payments to California and Minnesota Pending Review Results and Requests for Additional Documentation
On July 21, 2026, HHS and CMS jointly announced that they were deferring more than $1 billion in federal Medicaid payments to California and Minnesota until the states submit additional documentation showing that certain claims meet federal billing requirements. HHS Secretary Robert F. Kennedy, Jr. and CMS Administrator Dr. Mehmet Oz said the federal government is withholding roughly $867 million from California and $199 million from Minnesota in Medicaid funding because financial audits revealed missing documentation for certain high-risk Medicaid claims. The deferment is part of the Trump Administration’s broader effort to combat fraud, waste, and abuse in the Medicaid program.
In the joint announcement, HHS and CMS stated that the agencies conducted focused financial reviews of claims submitted in California and Minnesota. Those reviews revealed, according to the agencies, a need for additional documentation and review to ensure the claims meet federal requirements before HHS and CMS will release federal funds. The joint announcement emphasizes that the payment deferrals are not permanent funding cuts.
As to the specific documentation issues, CMS stated that it identified spending growth above the national average for certain in-home care programs and other claims in California. As a result, CMS said it would defer approximately $867.5 million in federal Medicaid payments until California produces information and documentation needed to support those claims. With respect to Minnesota, CMS reviewed Medicaid claims in 14 high-risk service areas. The findings of that review showed claims with potential eligibility or billing concerns and claims that required additional documentation. CMS said it would defer approximately $199 million in federal Medicaid payments to Minnesota. According to CMS, both states will be able to provide additional documentation to show the claims meet federal Medicaid requirements and clear the way for the federal funds to be released.
These payment deferrals reflect a broader trend in the current administration of efforts intended to combat fraud in federal healthcare programs. CMS previously announced in February that it would withhold $259.5 million in Medicaid funds from Minnesota and, in May, that it would withhold $1.3 billion in Medicaid funds from California. The payment deferrals also reflect what the government describes as a proactive approach to program integrity, including a shift from “pay and chase” to “detect and prevent” before federal dollars are disbursed.
The joint press release also notes that HHS will continue to exercise its exclusion authorities to remove bad actors from the Medicare and Medicaid programs. Secretary Kennedy also announced at a press conference on July 21, 2026, that HHS would delegate and share its exclusion power with CMS. The power to exclude providers has historically been reserved for the HHS Office of Inspector General.
A copy of the HHS-CMS joint press release is available here.
Reporter, Doug Comin, Atlanta, GA, +1 404 572 3525, dcomin@kslaw.com
Upcoming Events
What’s Happening With the NSA?
- July 30, 2026, 1:00 – 2:00 P.M. ET
- Virtual
Many providers rely on the No Surprises Act Independent Dispute Resolution (IDR) process to challenge low out‑of‑network payments. But the system is under increasing strain. Plans are suing providers for submitting allegedly ineligible disputes, and some are outright refusing to pay awards. At the same time, CMS‑appointed IDR entities are still struggling to manage the high volume of disputes.
This program will offer an update on the IDR process and key legal developments, including the long‑awaited IDR Operations Final Rule, recent trends in CMS IDR outcomes, new caselaw on the enforceability of IDR decisions in federal court, whether a circuit split may prompt Supreme Court review, the growing consensus among federal courts that health plans do not have a cause of action against providers for allegedly fraudulent IDR submissions, and alternative strategies for non-contracted provider underpayment disputes, including potential avenues for relief in state courts.
You do not have to be a client to attend, and there is no charge. RSVP by July 29. For questions, contact Sydney Forte.
Editors: Chris Kenny and Ahsin Azim
Issue Editors: Christopher Jew and Marcia Foti