As operational costs continue to rise, even incremental reductions in federal payments can materially impact hospital cash flow, margin performance, and long-term financial planning. One such reduction, often misunderstood but unavoidable, is the sequestration adjustment.
In this detailed guide, we break down what a sequestration adjustment is, how it impacts medical billing workflows, how the percentage is calculated, and what providers can expect in upcoming years, including the anticipated Medicare sequestration changes in 2026.
What Is a Sequestration Adjustment?
A sequestration adjustment is a mandatory federal budget reduction applied to Medicare Fee-for-Service (FFS) payments. Under the Budget Control Act, Medicare payments are reduced by up to 2%, applied after all routine adjudication steps (allowable, deductible, and coinsurance).
This is not a denial, error, or coding issue. It is a statutory federal reduction that all Medicare-participating hospitals must absorb.
Key Points for Hospital Finance Leaders
- Sequestration is not negotiable and not payer-specific; it applies to all Medicare FFS claims.
- It reduces only Medicare’s portion—never the patient’s responsibility.
- Applies to Part A, Part B, CAH, SNF, HHA, ESRD, and most outpatient services.
- Does not apply to Medicaid or commercial payers (except some Medicare Advantage plans with contract structures that mimic sequestration).
Why Does Medicare Apply Sequestration?
The Budget Control Act established automatic spending cuts when federal expenditures exceed predetermined limits. Medicare sequestration is simply the healthcare component of those cuts.
Why this matters to hospitals
- Sequestration is tied to federal budget policy, not healthcare performance.
- Cuts are projected to continue through 2031, with potential adjustments as early as 2026.
- CFOs must treat sequestration as a long-term revenue forecast variable, not a temporary cost.
In other words, sequestration is an operating reality, not an anomaly.
Is the Patient Responsible for Medicare Sequestration?
No.
Patients are never responsible for the sequestration reduction.
CMS explicitly states that:
- Providers cannot bill patients for sequestration
- Providers must absorb the reduction
- Only Medicare’s portion is reduced, not the patient’s 20% coinsurance
This is a compliance-critical distinction for revenue integrity teams.
How Sequestration Appears in Medical Billing & Payment Posting
Hospitals typically see sequestration reflected on Electronic Remittance Advice (ERA) using:
- CO-253 – Sequestration reduction
- Remark Code: Federal sequestration adjustment
This is not a denial code; it is an adjustment code.
Incorrect posting of CO-253 is one of the leading causes of:
- Inflated accounts receivable
- Inaccurate net revenue reporting
- Misaligned month-end reconciliation
- Variances between expected and actual Medicare payments
For large healthcare organisations processing millions in Medicare payments monthly, even a minor posting deviation can create substantial discrepancies.
How Is Medicare Sequestration Calculated?
Below is the Medicare sequestration calculation workflow presented in a structured table:
| Step | Description | Example Amount |
| Determine Medicare Allowable | The approved amount is based on Medicare’s fee schedule. | $100 |
| Apply Patient Deductible | Subtract any unmet deductible amounts (if applicable). | $0 (Satisfied) |
| Apply Coinsurance (20% Patient Responsibility) | Patient pays 20% of the allowable after the deductible. | $20 |
| Calculate Medicare Portion | Medicare pays the remaining 80% before sequestration. | $80 |
| Apply Sequestration Reduction (2%) | Sequestration applies only to Medicare’s payment portion—not the patient’s. | $1.60 |
| Final Medicare Payment to Provider | Medicare portion minus sequestration deduction. | $78.40 |
Formula Table
| Formula | Result |
| Sequestration Amount = Medicare Payment × 2% | $80 × 2% = $1.60 |
| Final Payment = Medicare Payment – Sequestration | $80 – $1.60 = $78.40 |
Detailed Example for Hospital Finance Teams
Below is a more advanced example tailored for hospital RCM leaders.
| Step | Amount |
| Billed Charges | $4,800 |
| Medicare Allowable | $1,950 |
| Deductible (Patient) | $240 |
| Coinsurance (20%) | $342 |
| Medicare Portion Before Sequestration | $1,368 |
| Sequestration Adjustment (2%) | $27.36 |
| Final Medicare Payment | $1,340.6 |
In a hospital environment where 30–40% of the payer mix is Medicare, sequestration can reduce annual net revenue by hundreds of thousands to millions of dollars, depending on service volume.
Impact of Sequestration on Healthcare Providers
Sequestration reduces revenue, which affects:
| Area Impacted | How Sequestration Affects It |
| Cash Flow | Even a 2% reduction significantly impacts high-volume practices, reducing overall incoming revenue. |
| Budgeting | Even a 2% reduction significantly impacts high-volume practices, reducing overall incoming revenue. |
| Contracting & Negotiations | Many providers attempt to renegotiate higher commercial reimbursement rates to balance out Medicare sequestration losses. |
| Revenue Cycle Management (RCM) | Payment posting teams must apply sequestration adjustments (CO-253) correctly to avoid inflated A/R and inaccurate financial reporting. |
Sequestration Denial Code: Not a True Denial
Although sequestration uses code CO-253, hospitals must understand, especially in internal audits, that:
- The claim was not denied
- There is no opportunity to appeal
- There is no corrective action plan
- Documentation or coding changes cannot prevent it
In revenue integrity audits, this code should be excluded from denial rate metrics to avoid skewing denial performance.
Medicare Sequestration 2026: What Hospitals Should Prepare For
While sequestration cuts remain at 2% today, federal budget projections indicate possible policy adjustments in 2026.
Hospital CFOs should prepare for:
- Potential temporary relief
- Potential re-indexing of the percentage
- Possible legislative shifts tied to healthcare spending caps
Financial modelling should incorporate multiple sequestration scenarios for an accurate long-term strategy.
Advanced Strategies Hospitals Use to Offset Sequestration Losses
Although sequestration cannot be avoided, hospitals can minimise its effect on net revenue and operational performance.
1. Strengthen Medicare Documentation & Coding Accuracy
Higher accuracy → higher allowable → smaller relative impact of sequestration.
2. Enhance Patient Access & Eligibility Workflows
Preventable eligibility issues reduce reimbursement far more than sequestration.
3. Improve Cost Structure in High-Volume Outpatient Areas
Since outpatient services generate the highest Medicare volume, improving efficiency yields better margin resilience.
4. Tighten Payment Posting & Automation
Even a 0.5% posting variance across Medicare volume can create multi-million-dollar discrepancies.
5. Evaluate Managed Medicare Contracts Carefully
Some MA plans emulate sequestration; others do not. Contract review may uncover revenue opportunities.
6. Strengthen Internal Benchmarking
Track:
- Net revenue per encounter
- Case mix index (CMI) shifts
- Contribution margin by service line
Sequestration is just one pressure point benchmarking identifies others
Compliance Considerations for Hospital Leaders
Sequestration has compliance implications tied to:
- Cost reports
- Charity care policies
- Bad debt reimbursement
- Medicare Advantage contract rules
- Reconciliation processes
Correct categorisation of sequestration adjustments is essential for accurate reporting.
How Sequestration Affects Outsourced Billing & RCM Partners
Hospitals using outsourced billing partners typically benefit from:
- More accurate sequestration posting
- Lower denials in other categories
- Cleaner AR reporting
- Reduced month-end variance
- Improved insight into federal payment trends
This is where organisations like RevenueES can provide value—through structured Medicare workflows, payment integrity models, and compliant posting standards.
Conclusion
As the healthcare industry anticipates possible changes in Medicare sequestration 2026, large healthcare organisations must maintain strong financial models, accurate posting workflows, and deep visibility into reimbursement trends.
Hospitals seeking stronger Medicare payment integrity, cleaner AR, and accurate sequestration reporting often rely on specialised RCM partners like RevenueES to support operational excellence and financial performance.
