Counting the Days: Fifth Circuit Reverses Texas Hospitals’ DSH Rule Challenge

The US Court of Appeals for the Fifth Circuit on December 9, 2025 reversed and remanded a decision from the US District Court for the Northern District of Texas that had vacated a 2023 federal regulation that threatened to reduce supplemental payments for disproportionate share hospitals and potentially impact qualification for 340B drug discounts.

The court holding had two impacts—one administrative and one substantive. First, it found that courts lack jurisdiction to review claims arising under the Medicare statute until a hospital submits its cost report, receives a final payment determination from a Medicare administrative contractor, and appeals said determination to the Provider Reimbursement Review Board (PRRB)—a process that could take years.

Second, by reversing the 2024 lower court holding that enjoined the Centers for Medicare and Medicaid Services (CMS) from applying the 2023 federal regulations, hospitals are subject to a rule penalizing hospitals in states that pursued alternatives to Medicaid expansion by creating Medicaid uncompensated care pools.

Calculating the Medicaid Fraction

Hospitals serving a high proportion of low-income patients may receive disproportionate share hospital (DSH) payments in addition to standard Medicare reimbursement. DSH payment calculations are highly complex but, at a high level, depend on the percentage of a hospital’s patient days spent treating patients “eligible for medical assistance under a State plan approved” under the Medicaid statute. [1] This is called the Medicaid fraction:

# of Medicaid-eligible patient days (excluding Medicare Part A)
# of hospital’s patient days

In August 2023, CMS passed a regulation excluding patients receiving benefits under “uncompensated/undercompensated care pools” established by a CMS-approved section 1115 demonstration project. [2] Uncompensated care pools are used by approximately half a dozen states (including California, Texas, Massachusetts, and Florida) to help healthcare providers defray the costs of care for which they are not paid, such as uninsured emergency care, charity care, and bad debt. CMS rationalized the exclusion by stating that the payments directly benefit providers, not the patients, and therefore, the patient days should not be counted in the Medicaid fraction. [3]

Importantly, the Medicaid fraction affects more than just DSH payments. A hospital’s eligibility for the 340B drug discount program is tied to its DSH patient percentage, and reductions to the Medicaid fraction will reduce this amount. Once a hospital is disqualified from the 340B program, it cannot later recoup discounts it would have received, even if it proves that the initial eligibility decision was incorrect.

In 2024, a group of Texas hospitals that expected to lose more than $10 million in annual DSH payments and eligibility for the 340B program based on the 2023 final rule sued CMS. The Texas hospitals argued that the rule violated precedent in Forrest General Hospital v. Azar, [4] that the numerator of the Medicaid fraction must include hospital days of those treated pursuant to 1115 demonstration waivers. The district court adopted the Fifth Circuit’s Forrest General precedent regarding the meaning of the DSH statute and held the 2023 rule to be unlawful.

The Fifth Circuit Decision

However, rather than address the substance of its prior precedent as applied to CMS’s 2023 rule, the Fifth Circuit’s 2025 ruling centered on whether the district court had subject-matter jurisdiction to hear the hospitals’ challenge before the “Medicare channeling scheme” was exhausted. The court explained that the US Congress has “divested courts of subject-matter jurisdiction on any claim arising under the Medicare statute” except for the sole and narrow avenue for judicial review provided in 42 USC § 405(g). To invoke judicial review, hospitals must first present their claim to the agency and receive a “final decision” following a hearing. This presentment requirement is nonwaivable, and only after exhausting administrative remedies (or their waiver) may a hospital seek court review.

Here, the Fifth Circuit held that the Texas hospitals did not present a reimbursement claim to CMS because they sought to challenge the regulation preemptively before filing cost reports or receiving a final determination of their DSH payments. The court noted that only after receiving a Notice of Program Reimbursement (NPR) can hospitals appeal to the PRRB and then, if needed, seek judicial review. This was the case even though the hospitals had presented comments to the proposed rule and were dissatisfied with the final rule published by CMS.

The Fifth Circuit also rejected the Texas hospitals’ argument that channeling was unnecessary because their claim arose under the Public Health Service Act’s 340B program, not Medicare. According to the court, the Medicare statute provides the standing and substantive basis for the case, and the downstream impact on 340B does not exempt hospitals from the Medicare channeling requirement.

The Fifth Circuit also rejected the hospitals’ argument that it was exempt from channeling because the administrative processes would result in a “complete preclusion of judicial review” since some hospitals could lose 340B eligibility without the capacity for retroactive recovery of discount eligibility. The Fifth Circuit acknowledged the “delay-related hardship” but determined that such costs “are not sufficient to exempt them from the channeling requirement” as long as hospitals remain free to challenge DSH reimbursements after the administrative process is complete.

Key Takeaways

The Fifth Circuit’s decision has direct implications for hospitals in states operating Medicaid 1115 demonstration projects with uncompensated care pools and any hospitals seeking to challenge agency rules impacting Medicare payments in court. In the Fifth Circuit, a final rule is not the final payment determination triggering the right to a PRRB appeal and judicial review under 42 USC 1395oo(a)(2). Instead, the hospitals must make a presentation by virtue of filing their cost reports for the period impacted by the rule (and await the issuance of an NPR) before PRRB jurisdiction attaches.

Hospitals filing cost reports should carefully consider the impact of the Fifth Circuit’s decision on the patient days included in their Medicare fractions in order to ensure compliance with the 2023 rule, which stands to lose its vacated status upon remand. Hospitals should also prepare to timely challenge adverse payment determinations within the administrative framework, paying careful attention to cost reporting protest instructions. Finally, hospitals at risk of losing 340B eligibility due to reduced DSH percentages must consider the practical consequences of delay and weigh strategies for preserving eligibility, recognizing that retroactive qualification is unavailable under current program rules.

The decision underscores the importance of monitoring regulatory developments and preparing for the administrative steps required to preserve rights to future reimbursement and related program benefits.