Twenty-six cost-reimbursed hospitals (e.g., critical access hospitals) in Illinois challenged the Centers for Medicare and Medicaid Services’ (CMS) denial of approximately $4 million in costs claimed by the hospitals for a tax assessment levied upon each hospital by the State of Illinois as a part of the state’s financing of its Medicaid program.  The hospitals claimed that the tax assessment was an allowable cost under the applicable Medicare regulations and Provider Reimbursement Manual (PRM) Sections 2122.1 & 2122.2.  According to the hospitals, the tax assessment was approved by CMS as part of the Illinois State Plan for its Medicaid program, and should therefore be considered an allowable cost because it was not specifically excluded by Section 2122.2 of the PRM that lists “Taxes Not Allowable as Costs.”  In contrast, the CMS Administrator contended that the tax assessment must be offset by the “refund” the hospitals received from the payment fund established by the Illinois Medicaid program, and that the hospitals did not truly “incur” the costs based on the nature of the tax assessment.

The U.S. District Court for the Central District of Illinois dismissed the hospitals’ claims and ruled in favor of CMS’s interpretation that the hospitals could not claim the tax assessment as an allowable cost.  Abraham Lincoln Mem. Hosp. v. Sebelius, No. 3:10-cv-03122 (Jun. 8, 2011, C. D. Ill.).  The Court found that the full tax assessment was not an incurred cost because under the terms of the Illinois statute, the hospitals did not have to pay the tax until the hospitals received the fund payments from the Medicaid program.  The Court held that CMS’s approval of the Medicaid State Plan Amendments incorporating the tax assessment did not constitute a determination by CMS that the tax assessments were not refunded by the Medicaid fund payments to the hospitals.  According to the Court, “finding that the tax was a permissible tax for purposes of matching federal funds under Medicaid is not dispositive of whether those same taxes are actually incurred and are ‘reasonable costs’ under the Medicare statute.”

The Court’s decision adds support for the “clarification” published by CMS in an August 16, 2010 rulemaking statement (adopted after the litigation was ongoing) that Sections 2122.1 and 2122.2 of the PRM regarding allowable taxes must be read in the context of the general rules governing Medicare cost reimbursement, which provide in part that the “true costs of the goods or services is the net amount actually paid for them.”  With a variety of state tax financing mechanisms for the Medicaid program across the several states, the determination of an allowable tax may become a complicated analysis.  While there are a limited number of hospitals for which reasonable cost reimbursement is still relevant, for those hospitals, the Illinois’ Court decision and recent CMS policy instruct that a careful evaluation of the particulars of a Medicaid provider tax scheme will be necessary for determining whether such taxes can be claimed as an allowable cost under the Medicare program.

For a copy of the decision, click here.