backCMS Proposes Sweeping Cuts to Medicaid State Directed Payments: Key Takeaways from the Proposed Rule
On May 20, 2026, CMS published a proposed rule that would slash Medicaid managed care State Directed Payments (SDPs) and certain fee-for-service targeted practitioner payments. The proposed rule implements section 71116 of the Working Families Tax Cut (WFTC) legislation, also commonly referred to as the One Big Beautiful Bill Act, and responds to a June 2025 Presidential Memorandum on Medicaid. If finalized, the rule would drastically reduce Medicaid payments to providers by approximately $775 billion over 10 years by shrinking provider payment rates under SDPs and phasing down existing SDP payment arrangements that exceed the new limits. These reductions would greatly impact financial operations for hospitals and practitioners in the vast majority of states.
SDPs are supplemental payment arrangements that enable states to direct Medicaid managed care health plans on how to reimburse providers. Since 2016, the use of SDPs has expanded from two states to forty-one states, and SDP spending now accounts for over a quarter of all Medicaid managed care payments to providers. SDPs are an attractive payment program for states because CMS has historically permitted (and supported) directed payments up to average commercial rates (ACR). SDPs have become a lifeline for many providers because SDPs help close the gap between typically depressed base Medicaid rates and the real expense of delivering and improving quality care.
The WFTC legislation, enacted on July 4, 2025, directed the Secretary of HHS to revise regulations to limit the total payment rate for certain SDPs. The proposed rule implements that statutory mandate while also proposing to extend payment limits beyond the four service categories identified in the statute to all SDPs and certain FFS targeted payments. This article highlights the key takeaways.
New Payment Rate Limit Tied to Medicare
CMS proposes cutting SDP payment rates from ACR to 100% of the total published Medicare payment rate for Medicaid expansion states and 110% of the total published Medicare payment rate for non-expansion states. Where no comparable Medicare rate exists, the limit would default to the Medicaid state plan approved rate. Notably, CMS proposes applying these Medicare limits on a provider-specific and service-specific basis at the individual claim or service level, rather than using a traditional aggregate Medicare Upper Payment Limit (UPL) methodology. This approach will likely impose significant administrative burdens on states, which must now determine Medicare-equivalent rates for each provider and service. For providers without direct Medicare rate analogs, such as children’s hospitals, CMS seeks comment on potential Medicare cost-based calculation methods states could use to determine an appropriate Medicare rate equivalent. Importantly, children’s hospitals are a primary provider of services to the country’s single largest group of Medicaid beneficiaries: children.
Extension of the Payment Limit to All Services
Section 71116(a) of the WFTC legislation specifically addressed four service categories: inpatient hospital services, outpatient hospital services, nursing facility services, and qualified practitioner services at academic medical centers. However, CMS proposes extending the new Medicare payment rate limit to all SDPs for all services, effective for rating periods beginning on or after January 1, 2029. This broader application forecloses arguments that certain provider types, including behavioral health providers and physicians, might be excluded from the new caps. The extension limits states’ ability to create alternative SDP structures for these providers once grandfathered SDP arrangements have phased down.
Phase Down of Grandfathered SDPs
SDPs meeting certain criteria are eligible for a temporary grandfathering period under the WFTC legislation. CMS proposes that the total dollar amount of a grandfathered SDP must be phased down by 10 percentage points annually, calculated as 10% of the gross grandfathered payment amount, beginning with the first rating period on or after January 1, 2028. This proposed methodology accelerates the phase down period, as compared to a year-over-year 10% reduction. CMS also clarifies that the grandfathered amount is the total payment amount from Question 4 on the approved grandfathered preprint, and where a state has multiple preprints for a single SDP qualifying for grandfathered status, the preprint with the higher approved amount will control.
Elimination of Uniform Rate Increases
CMS proposes eliminating uniform rate increases as a permissible SDP structure for all new or non-grandfathered SDPs effective for rating periods beginning on or after January 1, 2028. Grandfathered SDPs may continue to use uniform rate increases only until the SDP reaches the new payment limit. CMS’s rationale appears directed at states that have used uniform rate increase structures to create what the agency views as problematic pay-to-play arrangements. However, the elimination removes significant state-specific flexibility and discretion to use uniform rate increases for access and adequacy purposes. Once the new provider-specific, service-specific limit applies, uniform rate increases may be administratively difficult or infeasible regardless, as states would need to ensure each individual provider’s payment does not exceed its specific Medicare-equivalent cap per service.
Fee-for-Service Targeted Payments
The proposed rule extends similar limits to targeted Medicaid practitioner payments in FFS delivery systems. States with approved state plan payments exceeding the proposed limits would be required to submit a state plan amendment to remove or update those payments no later than the first state fiscal year beginning on or after January 1, 2029.
The proposed rule is available here. CMS’s fact sheet on this proposed rule is available here. Finally, CMS’s press release is available here.
Public comments on the proposed rule are due by July 21, 2026. Stakeholders should closely analyze the provider-specific and service-specific payment limit methodology, model the financial impact of the phase down timeline on existing arrangements, and evaluate whether alternative approaches (such as aggregate UPL-based limits or cost-based calculations for IPPS-exempt providers) should be proposed in comments. The administrative complexity of implementing individualized Medicare rate comparisons at the claim level will likely be a significant area of focus in comments, as will the compressed phase-down timeline for states with large existing grandfathered pools.
Reporters, Dennis Mkrtchian, Los Angeles, +1 213 218 4046, dmkrtchian@kslaw.com; Catherine Kirkland, Washington, D.C., +1 202 626 9265, ckirkland@kslaw.com
Also In the News
On May 18, 2026, HHS announced a restructuring of its Office for Civil Rights (OCR). OCR is a law enforcement agency within HHS that enforces laws protecting civil rights, conscience and religious freedom, and health information privacy and security. The reorganization divides enforcement of these laws into three separate divisions based on subject matter expertise: the Conscience and Religious Freedom Division (CRFD), the Civil Rights Division, and the Health Information Privacy, Data, and Cybersecurity Division. This restructuring follows previous organizational changes to OCR in the first Trump Administration in 2018 (adding the CRFD) and the Biden Administration in 2023 (dissolving the CRFD and combining it and the Civil Rights Division into the Policy Division). HHS stated that it does not expect the reorganization will reduce OCR’s workforce. The HHS announcement of the reorganization is available here.
For questions, please contact Sydney Forte.
Editors: Chris Kenny and Ahsin Azim
Issue Editors: Alek Pivec and Jenna Anderson