A three-judge panel of the U.S. Court of Appeals for the Seventh Circuit (the “Seventh Circuit” or the “Court”) upheld summary judgment in favor of the Secretary of the U.S. Department of Health and Human Services in a suit brought by nineteen Illinois hospitals (the “Hospitals”) over Medicare reimbursement of provider taxes paid by the Hospitals into a state Medicaid fund.  Abraham Lincoln Memorial Hospital v. Sebelius, No. 11-2809 (7th Cir. October 16, 2012).  In affirming the decision by the Central District of Illinois (the “District Court”)—which upheld the CMS Administrator’s decision that certain provider taxes paid in 2004 and 2005 should be offset by “refunds” in the form of hospital access improvement payments—the Seventh Circuit praised the District Court, calling its decision “well-reasoned and comprehensive.”

The litigation stems from Illinois’ 2004 Hospital Provider Funding law, which imposed a tax on inpatient services of $84.19 per hospital “occupied bed day” (the “Tax Assessment”).  The Illinois Department of Public Aid was responsible for collecting the Tax Assessments, and it was to deposit all moneys received into a hospital provider fund (the “Fund”).  The law also required the Department to make hospital access improvement payments (the “Access Payments”) to certain hospitals from the Fund.  A hospital’s payment of the Tax Assessment was contingent upon actual receipt of the Access Payments.

The Hospitals sought reimbursement for services provided to Medicare patients on a reasonable cost basis and included in their cost reports the Tax Assessments they paid as a reasonable cost to be reimbursed under Medicare.  The fiscal intermediary (“Intermediary”) disallowed the Tax Assessment payments as costs and adjusted the Hospitals’ reimbursement by the Access Payments the Hospitals received.  The Hospitals appealed the Intermediary’s decision to the Provider Reimbursement Review Board (the “Board”), which reversed the Intermediary and found that the Tax Assessment was an allowable cost under Medicare, the Tax Assessment was a permissible tax under Medicaid and that the Access Payments were not a “refund” of the Tax Assessment.

The Intermediary sought review of the Board’s decision, and the CMS Administrator reversed, holding that the Tax Assessment was an allowable cost, but that the Access Payments were properly treated as refunds of the Tax Assessment.  According to the Administrator, the legislative language enacting the Tax Assessment linked the Tax Assessment to the Access Payments, and, therefore, the Tax Assessments were properly offset against the Access Payments.  Thus, the allowable tax was properly calculated as the amount of the Tax Assessment less the amount refunded by the State of Illinois in the form of Access Payments.  The Hospitals then filed suit in the Central District of Illinois, alleging that the Administrator’s decision violated the Administrative Procedure Act (the “APA”).  The District Court granted summary judgment in favor of the Secretary, finding that the Secretary’s interpretation of the regulations was not arbitrary and capricious, and was supported by substantial evidence.

The Seventh Circuit affirmed, rejecting multiple arguments asserted by the Hospitals.  Specifically, the Court held that the Administrator’s decision was not arbitrary, capricious or contrary to law, as the Administrator did not misapply the regulatory definition of “refund,” and the decision was supported by substantial evidence.  The Court found there was a clear relationship between the Tax Assessment and the Access Payments, and rejected the Hospitals’ argument that the Access Payments could not be refunds since they were not calculated based on the amount of the Tax Assessment the Hospitals paid.  Additionally, the Court rejected the Hospitals’ argument that the Administrator applied a “linkage” concept rather than the statutory standard of costs “actually incurred.”  Rather, the Court found that the Administrator assessed whether the Access Payments served to reduce a related expense such that they were a refund of the Tax Assessments, and concluded that they were.  The Court also rejected the Hospitals’ view that the Administrator’s decision was invalid since it was not adopted in compliance with the notice and comment period requirements of the APA, finding that the administrator’s decision qualified as “adjudication” rather than a rulemaking.    

The Seventh Circuit’s decision comes one month after the Eighth Circuit’s decision in Kindred Hospitals East, LLC v. Sebelius, which also upheld the CMS Administrator’s denial of “refunded” costs associated with the Missouri Medicaid provider tax.  While the decisions ultimately rest on the specifics of the particular states’ Medicaid provider tax, these recent circuit court decisions illustrate that courts are giving the agency broad discretion to make its determination on the allowable nature of a particular tax.

For a copy of the Seventh Circuit opinion, please click here.