H.R.1 Medicaid Implementation Update: Community Engagement Rule Challenged in Court and Additional Guidance Released

Since our recent updates on Centers for Medicare & Medicaid Services (CMS) guidance related to H.R. 1 (known as the Big Beautiful Bill and, more recently, the Working Families Tax Cut (WFTC) legislation), developments have continued on various fronts. Less than a month after the Medicaid Community Engagement Requirement (CER) Interim Final Rule was published, 25 states and the District of Columbia filed a lawsuit challenging the rule.  More broadly, CMS has continued to release guidance to support state implementation. This article shares the latest developments. 

Lawsuit Challenging Community Engagement Requirement Rule 

On June 29, 2026, 25 states and DC filed a lawsuit against the CMS and the U.S. Department of Health & Human Services (DHHS) challenging the Interim Final Rule (IFR). The lawsuit claims that the IFR violates the Administrative Procedures Act and the Spending Clause of the U.S. Constitution, places additional burdens on states, and puts vulnerable populations at risk of improperly losing coverage.    

Challenged Provisions 

Specifically, plaintiff states challenge the IFR’s:  

• Approach to the Medical Frailty Exclusion, which narrows the exclusion from the CER requirement for those who are “medically frail” to individuals whose conditions significantly impair their ability to meet community engagement requirements. The states argue that this limitation is narrower than the exclusion authorized under H.R. 1 and CMS’s preliminary guidance, and that the IFR fails to provide states with a clear framework for determining when a condition “significantly impairs” an individual’s ability to meet community engagement requirements. They specifically note the IFR “creates new requirements that constrain who is exempt due to their medically frail status and force medically frail individuals in need of healthcare to jump through unnecessary administrative hoops to get and retain life-saving healthcare coverage.”  

• Limitation of substance use disorder (SUD) Exclusion, which prohibits individuals “in stable recovery” (defined as those in recovery from a substance use disorder for five or more years) from qualifying as medically frail based on the assumption that their condition will no longer significantly impair compliance with CER. Similar to their arguments regarding medical frailty, plaintiff states argue that this restriction conflicts with H.R. 1, which categorically exempts individuals with SUDs from community engagement requirements.   

• Limitations on the Emergency Declaration Hardship Exception, which, similar to the medical frailty test, restrict the declared emergency short-term hardship exception to circumstances in which the individual can demonstrate that the emergency impacted their ability to demonstrate community engagement. Plaintiff states again argue that these limitations are inconsistent with the broader exception authorized by H.R. 1, and that the rule improperly requires state Medicaid agencies to determine whether an emergency impairs community engagement compliance for a large groups of individuals, despite providing no standards or guidance for making such determinations.   

• Divergent Approaches to Self-Attestations: Beginning in 2028, states may only accept attestations in two situations:  

• • If they cannot verify compliance, exceptions or exclusion through available data sources and documentation is not “reasonably available.”  

• • One additional time per review period for the medically frail.  

• • Plaintiff states argue that the IFR provides no meaningful guidance on the meaning of “reasonably available” and departs from both the statute and CMS’s prior communications and preliminary guidance, opening states up to future penalties if CMS determines that the state accepted a self-attestation when documentation was, in fact, “reasonably available.” With respect to medically frailty, the states note that, while the rule limits an individual’s ability to self-attest as medically frail only once during a period of enrollment starting in 2028, an individual who loses coverage can reapply and submit a new self-attestation at the start of a subsequent enrollment period, which is inconsistent and may increase unnecessary coverage churn, administrative burden, and costs for states, while disrupting continuity of care for Medicaid beneficiaries.   

• Renewal Procedures and Timelines, which plaintiff states argue effectively shortens the amount of time individuals have to demonstrate compliance with community engagement requirements. H.R. 1 allows Medicaid enrollees to satisfy community engagement requirements based on one or more months of compliance, as determined by the state, during the period between eligibility determinations. Plaintiff states contend that the timelines for notices and documentation for those for whom compliance or exclusion/exception cannot be verified ex parte, as outlined in the IFR, undermine this statutory flexibility by limiting the number of months available to demonstrate compliance in practice.   

• Limitations on the Use of Adjudicated Claims and Encounter Data for ex parte verifications to those from the preceding 12 months. Plaintiff states argue that this restriction undermines states’ ability to identify individuals who qualify for exclusions, contending that the rule fails to account for significant delays in Medicaid claims processing between the provision of a Medicaid service, submission of a claim, and its adjudication. Plaintiff states also argue that a 12-month lookback period may not capture individuals with permanent disabling conditions who require little or no ongoing treatment, resulting in claims data that do not accurately reflect their medical status.   

• Timeline for Short-Term Hardship Exception, which requires individuals to experience a short-term hardship during the compliance review period immediately preceding the month of application to be eligible for an exception. Plaintiff states contend that this approach excludes hardships experienced in the application month itself, delaying access to coverage even for individuals who are currently experiencing circumstances that would otherwise qualify them for a short-term hardship exception.   

The plaintiff states also argue that, on the whole, the IFR is an unjust, unexpected, and coercive implementation of H.R. 1 and, therefore, an unconstitutional exercise of Congress’s Spending Clause authority. The plaintiffs note that the IFR contains significant ambiguities, thereby failing to provide states with clear notice of the requirements necessary to receive federal Medicaid dollars. The plaintiffs also claim that the IFR effectively imposes retroactive conditions that states could not have reasonably anticipated when developing their H.R. 1 implementation plans because it departs from the statute and prior CMS guidance. 

Relief Sought  

Plaintiff states have asked the court to:  

• Delay the effective date of the challenged provisions of the IFR while the case is being litigated  

• Declare the challenged provisions unlawful  

• Issue preliminary and permanent injunctions preventing CMS from implementing or enforcing the challenged provisions against plaintiff states  

• Vacate and set aside the challenged provisions  

• Grant any additional appropriate relief  

Absent any immediate judicial intervention, plaintiff states will likely move forward with implementation of community engagement requirements in January of next year. 

Other Recent CMS Guidance  

Section 71116 – State Directed Payments 

CMS published a proposed rule implementing the H.R.1 changes to Medicaid state directed payments (SDPs) through Medicaid Managed Care Organizations on May 20, 2026. Public comments on the rule were due by July 21, 2026. 

The rule seeks to implement the H.R.1 requirement capping certain SDPs at 100 percent of Medicare payment rates in Medicaid expansion states and 110 percent in non-expansion states, with limited grandfathering for existing arrangements. Under H.R.1, these caps apply to inpatient hospital services, outpatient hospital services, nursing facility services, and qualified practitioner services at academic medical centers. The rule proposes to extend this limitation to all SDPs for rating periods beginning on or after January 1, 2029, and to eliminate uniform increase SDPs for rating periods beginning on or after January 1, 2028. States could instead adopt minimum or maximum fee schedules that do not exceed the applicable payment limits without prior CMS approval. 

The proposed rule would also cap certain Medicaid FFS targeted payments at the same Medicare-based thresholds. States with existing payment arrangements above those limits would need to revise them through a Medicaid State Plan Amendment by the first state fiscal year beginning on or after January 1, 2029; new proposals would need to comply upon the rule’s effective date. 

Section 71118 – Budget Neutrality 

On June 11, 2026, CMS released a State Medicaid Director letter outlining guidance regarding H.R.1 changes to how states demonstrate budget neutrality for Section 1115 Demonstration Waivers. Under H.R. 1, beginning January 1, 2027, the CMS Chief Actuary will need to certify that a demonstration is not expected to increase federal Medicaid costs compared with what those costs would have been without the Demonstration. The letter outlined a new methodology for addressing expenditures that could be authorized outside of a waiver. CMS also intends to limit rollover savings to the most recent demonstration period, generally up to five years, and apply unused savings only to the immediately following renewal period. CMS expects current review practices to continue for Demonstration approvals issued before January 1, 2027, and anticipates providing additional guidance and technical assistance before that date. 

Prior “fast-track” review guidance was rescinded by CMS for Section 1115 Waiver extensions, based on the concern that the process would make it difficult to evaluate renewals under the new budget neutrality requirements. 

Section 71115 – Provider Taxes 

On July 21, 2026, CMS published a proposed rule implementing new H.R.1 indirect hold harmless thresholds for health care-related taxes, also known as provider taxes. The rule includes new definitions, including updating earlier guidance. The proposal would also: revise how CMS determines whether provider taxes are permissible, eliminate the current “75/75” test; add health insurers as a permissible taxed provider class; and require states to submit additional tax data. 

The rule is effective October 1, 2026, and comments on the proposed rule are due September 21, 2026. 

Other CMS Guidance 

CMS also issued a CMCS Informational Bulletin on July 21, 2026, reminding states to reassess Medicaid and CHIP eligibility when they become aware of changes in a beneficiary’s immigration status. Though the guidance is not explicitly tied to H.R.1, H.R.1 did make changes to Medicaid eligibility based on immigration status. The bulletin addresses the termination of parole under Department of Homeland Security (DHS) programs for certain Cuban, Haitian, Nicaraguan, and Venezuelan (CHNV) nationals and directs states to identify affected beneficiaries, reverify immigration status through DHS’s SAVE system, and conduct eligibility redeterminations. 

Before taking adverse action, states must determine whether affected individuals qualify under another eligible immigration status or other basis of eligibility, including emergency Medicaid where applicable, and provide required notices and appeal rights before terminating or reducing benefits. 

PCG’s subject matter experts will continue to monitor federal guidance, pending litigation, and state implementation activity related to H.R. 1 Medicaid changes and will share updates as additional developments occur.