Despite many changes made in 2010 and 2011 to Medicare’s payment system for short-term stays in skilled nursing facilities, a flawed payment structure continues to underpay facilities for certain types of patients and overpay for others. The flaws in the payment structure create incentives to selectively admit or refuse patients based on the type and complexity of their conditions, while payments that vary with level of use encourage providers to furnish therapy services, such as rehabilitation care, that some patients might not need. We propose an alternative payment design and demonstrate that it would dampen such incentives by making payments that are more closely matched to costs and based on characteristics of the patients treated. We propose replacing the existing therapy component of payment with one that varies payments according to the expected care needs of the patient and adding a separate payment component that covers drugs and other nontherapy ancillary services, such as support for patients on ventilators. We also propose adding an outlier policy to provide additional reimbursement for patients requiring exceptionally high-cost care.