42 C.F.R. § 430.35 : Public Health — CENTERS FOR MEDICARE & MEDICAID SERVICES, DEPARTMENT OF HEALTH AND HUMAN SERVICES — MEDICAL ASSISTANCE PROGRAMS — GRANTS TO STATES FOR MEDICAL ASSISTANCE PROGRAMS — GRANTS; REVIEWS AND AUDITS; WITHHOLDING FOR FAILURE TO COMPLY; DEFERRAL AND DISALLOWANCE OF CLAIMS; REDUCTION OF FEDERAL MEDICAID PAYMENTS — Withholding of payment for failure to comply with Federal requirements

(a) Basis for withholding. CMS withholds payments to the State, in whole or in part, only if, after giving the agency reasonable notice and opportunity for a hearing in accordance with subpart D of this part, the Administrator finds-
(1) That the plan no longer complies with the provisions of section 1902 of the Act; or
(2) That in the administration of the plan there is failure to comply substantially with any of those provisions.

(Hearings under subpart D are generally not called until a reasonable effort has been made to resolve the issues through conferences and discussions. These may be continued even if a date and place have been set for the hearing.)

(b) Noncompliance of the plan. A question of noncompliance of a State plan may arise from an unapprovable change in the approved State plan or the failure of the State to change its approved plan to conform to a new Federal requirement for approval of State plans.
(c) Noncompliance in practice. A question of noncompliance in practice may arise from the State's failure to actually comply with a Federal requirement, regardless of whether the plan itself complies with that requirement.
(d) Notice and implementation of withholding. If the Administrator makes a finding of noncompliance under paragraph (a) of this section, the following rules apply:
(1) The Administrator notifies the State:
(i) That no further payments will be made to the State (or that payments will be made only for those portions or aspects of the program that are not affected by the noncompliance); and
(ii) That the total or partial withholding will continue until the Administrator is satisfied that the State's plan and practice are, and will continue to be, in compliance with Federal requirements.
(2) CMS withholds payments, in whole or in part, until the Administrator is satisfied regarding the State's compliance.

42 C.F.R. § 430.35