The Centers for Medicare & Medicaid Services (CMS) issued a proposed rule that would significantly limit Medicaid managed care State Directed Payments (SDPs) and certain fee-for-service payments. These changes seek to implement, and go well beyond, the relevant directives under the Working Families Tax Cut legislation (also known as the One Big Beautiful Bill Act).
Currently, the District of Columbia and 41 states have received CMS approval for hundreds of SDPs, many of which would be eliminated or substantially narrowed as a result of the rule change. In 2025, it was estimated that the One Big Beautiful Bill Act would result in $72 billion in federal Medicaid cuts through SDPs limitations over a 10-year period. CMS’s proposed rule drastically expands upon the Act’s SDP limitations, with CMS estimating that its proposal would result in $774.8 billion in state and federal Medicaid cuts over the same 10-year period.
Key Takeaways
- The proposed rule would cap SDPs for inpatient/outpatient hospitals, nursing facilities, and qualified practitioner services at academic medical centers at 100% of Medicare rates for Expansion States and 110% for Non-Expansion States (for rating periods starting July 4, 2025).
- The proposed rule would extend the above payment rate cap to all SDPs for all services (for rating periods starting January 1, 2029).
- The proposed rule would prohibit SDPs for new or renewed uniform increases (for rating periods starting January 1, 2028).
- Providers, states, and managed care organizations (MCOs) should consider submitting comments by July 21, 2026 and prepare for significant changes in Medicaid reimbursement and compliance obligations if the rule is finalized.
Background
Under Medicaid managed care delivery models, MCOs contract with CMS and receive capitated payments (per member per month) to provide healthcare coverage to enrollees. These contracts are risk-based, meaning the MCO assumes responsibility for the cost of the services covered under the contract and incurs loss if the cost of furnishing the services exceeds the capitated payments under the contract.
It is incumbent upon the MCOs to negotiate rates through private contracts with a network of healthcare providers. States are generally prohibited from interfering with an MCO’s payments to it network providers, except in limited circumstances where the goal is often increasing payment rates to improve access or quality of care.
These SDPs require CMS approval and may include
- minimum or maximum fee schedules,
- uniform payment increases for specific services, or
- value-based purchasing models for provider reimbursement (e.g., pay-for-performance arrangements, bundled payments, or other service payment models intended to recognize value or outcomes over volume of services).
42 C.F.R. § 438.6. The majority of states use average commercial rates to establish a benchmark payment level for SDPs to hospitals and nursing facilities. Average commercial rates tend to be higher than Medicare rates, and the increased payments support providers serving large percentages of Medicaid patients by offsetting shortfalls between low Medicaid reimbursement and the actual cost of care.
In a June 6, 2025 Presidential Memorandum, SDPs were described as creating an “imbalance between Medicaid and Medicare patients.” The One Big Beautiful Bill Act, signed into law on July 4, 2025, instructed the US Department of Health and Human Services to engage in rulemaking to reduce the upper limit for SDPs to inpatient hospitals, outpatient hospitals, nursing facilities, and qualified practitioner services at academic medical centers to 100% of Medicare payment rates for Expansion States and 110% for Non-Expansion States, with phase-in for certain approved grandfathered payments. (See our July 9 LawFlash.)
CMS’s Proposed Rule
Managed Care
The proposed rule would amend 42 CFR Part 438 to introduce sweeping changes to Medicaid managed care payments as follows:
- Initial SDP Payment Limits: For rating periods beginning on or after July 4, 2025, SDPs for inpatient hospital, outpatient hospital, nursing facility, and qualified practitioner services at academic medical centers would be capped at 100% of the total published Medicare payment rate in Expansion States and 110% in Non-Expansion States. If there is no applicable Medicare rate, the Medicaid fee-for-service state plan approved rate serves as the limit.
- Extension to All SDPs and Territories: The payment rate limit would be extended to all SDPs for all services, including those in US territories, for rating periods beginning on or after January 1, 2029. This proposal goes substantially beyond the four providers identified in the One Big Beautiful Bill Act and, based on CMS’s own estimates, would expand the Medicaid cuts by tenfold. This executive expansion may exceed the authority granted by the language of the statute.
- Elimination of Uniform Increase SDPs: For rating periods beginning on or after January 1, 2028, new or renewed uniform increase SDPs would be prohibited (with a limited exception for grandfathered SDPs) and only minimum and maximum fee schedule SDPs would be allowed.
- Grandfathering and Phase-Down: SDPs approved or submitted within 180 business days of the enactment of the One Big Beautiful Bill Act (i.e., by December 31, 2025) may qualify for a temporary grandfathering period, but must phase down by 10% of the grandfathered total dollar amount annually, starting on or after January 1, 2028, until the payment rate cap is reached.
- Impermissible “Gray Area” Redistribution Arrangements: The rule would prohibit “gray area” SDPs that require a portion of the payments to be allocated to the MCO for administrative activities or require paying any portion of an SDP to an entity other than the furnishing provider.
- Documentation and Oversight: States would be required to submit detailed documentation, including provider lists, NPIs, methodologies for compliance, and respond to CMS requests for information.
Fee-for-Service
The proposed rule would also amend 42 CFR Part 447 to introduce sweeping changes to Medicaid fee-for-service payments. Under the FFS models, state Medicaid programs dictate the reimbursement rates providers receive for specific services. Considering that these base rates are often lower than the actual cost of providing care, many states add supplemental payments that a specific class of providers (e.g., nursing facilities, mental health centers, physicians) may receive above standard base rates.
Currently, upper payment limits restrict federal matching funds so that aggregate payments for a specific class of providers do not exceed what Medicare would have paid for the same services. For example, states may offer supplemental Medicaid payments to particular types of hospitals above the Medicare payment rates as long as total payments for each class of hospitals are below the UPL in the aggregate.
CMS’s proposed rule would restrict individual, rather than aggregate, base and supplemental payments. Specifically, the rule would limit base and supplemental payments that target a subset of participating practitioners or providers (referred to as “targeted Medicaid payments”) to 100% of applicable Medicare payment rate for expansion states or 110% for non-expansion states, with exceptions for uniform statewide/geographic payments and payments already subject to other statutory or regulatory limits.
CMS specifically noted that this proposal would not apply to disproportionate share hospital payments, and states with noncompliant targeted Medicaid payments must submit State Plan amendments by the start of the first state fiscal year on or after January 1, 2029.
Looking Ahead
The CMS proposed rule represents a substantial shift in Medicaid payment policy beyond what was anticipated in the One Big Beautiful Bill Act, with major financial implications for states, providers, and MCOs.
CMS states that it seeks to reduce SDPs to prevent states from using provider taxes or intergovernmental transfers to fund the nonfederal share (i.e., the state-funded portion) of their Medicaid programs. However, this goal seems far attenuated from the immediate impact of the proposed rule, which would simply result in significant reductions in provider reimbursement, potentially compromising the states’ ability to protect providers with high volumes of Medicaid patients from short falls and financial instability. As such, it appears more likely that the goal is merely to reduce Medicaid spending.