Tipsheet

Centers for Medicare & Medicaid Services Just Closed a Major Tax Loophole

Amy Curtis
Amy Curtis  |  January 30, 2026 11:00 AM

The Centers for Medicare & Medicaid Services (CMS) announced a new rule that will put an end to a massive tax loophole that had federal taxpayers on the hook for paying for state-run Medicaid programs.

Medicaid was meant to be a federal-state partnership, where states were required to cover a significant portion of Medicaid costs. CMS said this is at least 40 percent of the non-federal share. Under current rules, the states can use healthcare-related taxes to finance that share. But some states figured out a loophole.

Under that loophole, states were able to raise taxes on Medicaid managed care organizations (MCOs) and other providers, making that tax revenue the state's money for Medicaid financing. That would then trigger matching federal dollars.

States would then reimburse the taxed entities, effectively with the matching federal funds, and the state would then avoid a real net cost.

CMS is now putting a stop to this.

Here's more:

Over time, states have gradually shifted their Medicaid financing responsibility to federal taxpayers through gimmicks such as this. Today’s action is about states investing their fair share in the Medicaid program instead of taking advantage of federal taxpayers.   

“We are bringing fairness, accountability, and integrity to Medicaid by restoring the Federal-State partnership,” said CMS Administrator Dr. Mehmet Oz. “Medicaid only works when every partner meets its obligations. States that have relied on loopholes to offload their responsibilities onto federal taxpayers undermined the law and directed additional Medicaid spending to favored providers instead of focusing on families who depend on this program. With this rule, CMS is ending these inappropriate schemes and ensuring every federal Medicaid dollar is used as Congress intended.”

For years, some states exploited healthcare–related tax structures to effectively push their share of Medicaid financing onto the federal government. From fiscal year 2012 to fiscal year 2024, the federal financing share of Medicaid increased from approximately 57 percent to 64.5 percent. [1]   These schemes imposed higher tax rates on Medicaid Managed Care Organizations (MCOs) or other Medicaid providers while using the proceeds to obtain federal matching dollars, effectively repaying providers for their tax costs with federal funds and sometimes producing massive state windfalls at federal expense. This particular gimmick draws down more than $24 billion annually for state budget purposes, including to reward special interest providers. In one state alone, these arrangements generated more than $13 billion.

Key provisions of the new rule include a prohibition on states imposing higher tax rates on Medicaid businesses, a closure of "back-door pathways" that block "vague, opaque, or indirect tax structures," and a strengthening of safeguards proposed last year that will allow CMS to enforce financing rules.

The rule also provides a transition timeline to give states a path to compliance by the end of FY 2028.

CMS Administrator Dr. Oz, said this rule will ensure that "every federal Medicaid dollar is used as Congress intended."

This new rule will restore Medicaid to its intended role: a federal-state partnership designed to help those in need. By closing the loophole that allowed states to shift their financial obligations to federal taxpayers, the rule reasserts a basic principle: accountability matters, and federal dollars should support patient needs, not state budget gimmicks.