On Thursday, July 31, 2025, CMS issued its annual Hospital Inpatient Prospective Payment System (IPPS) and Long-Term Care Hospital (LTCH) Prospective Payment System Final Rule for Fiscal Year (FY) 2026 (the Final Rule). In the Final Rule, CMS has updated the IPPS and LTCH payment rates, modified the hospital wage index, recalculated the labor-related share, and updated the uncompensated care payment factors. The agency also decided against finalizing changes it had proposed making to the payment formula for nursing and allied health programs. The agency estimates that the changes contained in the rule will increase aggregate IPPS payments by $5 billion in FY 2026 relative to FY 2025. Payments to LTCHs are projected to increase by $83 million in FY 2026 over the previous year.
Payment Rates Overview
In the Final Rule, CMS increased the operating payment rates for acute care hospitals by 2.6%, which reflects a market basket increase of 3.3% and a productivity adjustment of -0.7%. By comparison, in the proposed rule, CMS instead proposed an update of 2.4% reflecting a market basket of 3.2% and a productivity adjustment of -0.8%.
Commenters to the proposed rule said that the proposed market basket update vastly understated the actual growth in hospital costs. Many commenters blamed this discrepancy on CMS’s reliance on the Employment Cost Index (ECI), published by the U.S. Bureau of Labor Statistics, to measure changes in labor costs. By design, the ECI controls for changes in the composition of the labor pool, such as shifts from employee to contract labor. Given the increased utilization of contract labor among hospitals in recent years, the American Hospital Association and other commenters questioned whether the ECI adequately captures recent changes in hospital labor costs. The agency shrugged off these concerns, responding that the market basket update should not reflect changes in the labor pool.
CMS also finalized FY 2026 market basket percentage increase for the LTCH PPS, using the 2022-based LTCH market basket, for an increase of 3.4% that would result in an estimated increase in payments in FY 2026 of approximately $83 million.
The Wage Index
In the Final Rule, CMS officially finalized its decision to terminate the low wage index policy for FY 2026 and onward. Under this policy, which the agency first adopted in FY 2020 and continued through FY 2024, the agency made upward adjustments to the wage index values of hospitals below the 25th percentile nationwide, and reduced the standardized amount for all hospitals to budget neutralize the financial impact.
In 2024, the Court of Appeals for the District of Columbia ruled that the low wage index policy was unlawful. Bridgeport Hosp. v. Becerra, 108 F.4th 882 (D.C. Cir. 2024). In response to that decision, CMS issued an interim final rule (IFC) on October 4, 2024, updating the FY 2025 wage index to remove the low wage index hospital policy.
In the FY 2026 Final Rule, CMS announced that it is discontinuing the low wage index policy for FY 2026 and future years. Some commenters urged CMS to continue the policy, or to explore alternative policies to help low wage hospitals increase their wage index values. The agency responded that a solution would probably require changes to the Medicare statute.
To mitigate the impact of the discontinuation of the low wage index policy, CMS has finalized a transition policy for affected hospitals. Under this policy, in FY 2026, all hospitals will receive the greater of their FY 2026 wage index or 90.25% of their FY 2024 wage index. CMS has applied a -0.03% adjustment to the standardized amount to budget neutralize the financial impact of this transition policy.
Labor-related Share
In the Final Rule, CMS reduced the labor-related share for hospitals with a wage index of 1.0 or higher from 67.6% to 66.0%. The labor-related share is the portion of the standardized amount that is adjusted by the wage index. By statute, the maximum labor-related share for hospitals with a wage index below 1.0 is 62%. For all other hospitals, CMS determines the labor-related share every four years upon rebasing the standardized amount.
In the FY 2022 final rule, CMS rebased the rates based on the FY 2018 data and calculated a labor-related share of 67.6%, which remained in effect through FY 2025. In the FY 2026 Final Rule, CMS has rebased the rates using FY 2023 data and calculated a labor-related share of 66.0%, which should be in effect through FY 2029.
The agency explained that the labor-related share had declined because even though hospital compensation costs increased by 4% annually between FY 2018 and 2023, non-compensation costs had increased at a faster rate of 6% annually. Another factor driving the decline was CMS’s decision to exclude 41% of professional fee service costs—representing the agency’s estimate of professional services hospitals purchased from vendors outside of their labor market area.
Uncompensated Care Payment
The Final Rule includes CMS’s calculation of the uncompensated care payment pool for FY 2026. The Affordable Care Act (ACA) modified the Medicare DSH payment formula to reduce DSH payments to hospitals by 75%. Each year, CMS is required to estimate the dollar amount by which the ACA has reduced Medicare DSH payments (Factor 1) and multiply that amount by a factor equal to 1 minus the percent change in the uninsured population since the ACA was implemented in 2013 (Factor 2). The resulting payment pool is distributed to hospitals based on their proportionate share of uncompensated care as reported in Worksheet S-10 of their cost reports.
For FY 2026, CMS calculated a Factor 1 of $12.413 billion which is equal to 75% of the total amount of estimated Medicare DSH payments for FY 2026. By comparison, the Factor 1 CMS finalized in the FY 2025 final rule was $10.509 billion.
For Factor 2, CMS estimated that 8.7% of the population will be uninsured in FY 2026 compared to 14% when the ACA was implemented in 2013. Accordingly, for FY 2026 CMS has finalized a Factor 2 of 62.14% [1 – 0.3786 percent], which is an increase from the Proposed Factor 2 of 60.71% and a substantial increase over the FY 2025 Factor 2, which was 54.29%.
The product of the finalized Factors 1 and 2 for FY 2026 produces an uncompensated care pool of $7.713 billion. By comparison, the final uncompensated care pool for FY 2025 was $5.705 billion.
Changes to Nursing and Allied Health Payment Formula
In the Final Rule, CMS decided not to finalize changes it had proposed to the regulatory formula for calculating pass-through payments for nursing and allied health education (NAHE) programs. Medicare reimburses hospitals for the “net cost” incurred hosting NAHE programs. These payments are made on a pass-through basis, meaning they are paid outside of the prospective payment system.
In the proposed rule, CMS originally proposed to modify the regulatory formula for calculating “net cost.” Under the current formula, net cost is calculated by deducting tuition from the sum of direct and indirect costs (i.e., total costs). CMS originally proposed changing that formula so that tuition would be deducted from direct costs, and the result would be added to indirect costs.
- Current formula: net cost = total (direct + indirect) costs – tuition
- Proposed formula: net cost = (direct costs – tuition) + indirect costs
The difference between these formulae may appear subtle, but the effect of these changes is substantial. Under Medicare’s cost-finding rules, there is a proportional relationship between direct and indirect costs. When the direct costs that a NAHE program incurs increases, the amount of indirect costs that the program is allocated in the cost-finding process increases as well, so the hospital receives more in reimbursement for the program. Thus, the original proposal to deduct tuition from direct costs would have meant less indirect costs being allocated to NAHE programs in cost-finding, resulting in smaller NAHE pass-through payments.
CMS proposed this change in response to an unfavorable court decision. The agency had historically calculated net cost by deducting tuition from direct costs, the very approach it was proposing to codify. However, in a 2024 case where five plaintiff hospitals challenged the calculation of their NAHE pass-through payments, Judge Trevor McFadden of the D.C. District Court held that the current regulatory language requires CMS to deduct tuition from the sum of direct and indirect costs. Mercy Health-St. Vincent Medical Center d/b/a Mercy St. Vincent Medical Center v. Becerra, Case No. 22-cv-3578-TNM (D.D.C. Feb. 9, 2024) (St. Vincent). King & Spalding represented the hospitals in St. Vincent. In the proposed rule, CMS sought to align the regulation with its preferred approach for calculating net costs.
The agency did not stop there. It also proposed limiting the types of indirect costs that are eligible to be included in the net cost calculation. Specifically, CMS proposed to modify the regulatory text to specify that net costs only include those incurred “as a consequence of operating the approved educational activity.” The agency explained that this would exclude indirect costs that “benefit the hospital as a whole,” such as “[a]dmissions” and “[t]elecommunications,” because these are costs that would be “incurred in the absence of the provider’s NAHE program.” This change would have effectively eliminated most if not all indirect costs for NAHE programs.
On behalf of the St. Vincent plaintiffs, King & Spalding submitted a comment letter in opposition to the proposed changes. In the letter, King & Spalding argued that CMS’s proposal cannot be reconciled with the St. Vincent decision, and that stripping indirect costs out of NAHE payment is contrary to the statute.
In the Final Rule, CMS noted that the agency received “many comments in opposition to our proposal,” and that “[d]ue to the number and nature of the comments that we received, and after further consideration of the issue, we have decided not to finalize changes to our existing policy in this final rule.” The agency noted that it might revisit the net cost calculation in future rulemaking.
The Final Rule is available here, and a CMS fact sheet is available here.
