NY Proposal Tries to Make Clawback Tax Deductible—But Will the IRS Agree?

New York’s proposed amendment to Tax Law § 954(a)(3), included as Part T in the State Senate’s One-House Budget Bill (S.3009-B), tries something bold: It seeks to recharacterize part of the state estate tax as a deductible debt. Specifically, the proposal would deem the portion of the estate tax attributable to lifetime gifts made within three years of death—the so-called "clawback tax"—to be an "obligation of the decedent." The goal is straightforward: Maximize federal deductions for New York estates. But will the IRS go along with it?

This post explains why New York's attempt to secure federal deductibility for its recharacterized tax is doubtful:

• Substance over form: Calling a tax a "debt" doesn't change its true nature.
• Federal regulations narrowly define what qualifies as a deductible debt under IRC § 2053.
• As a hybrid tax/debt statute, the proposed NYTL § 954(a)(3) may raise an unsettled question of state law—shifting the analysis from Erie to Bosch, and allowing the IRS to interpret New York law rather than simply apply it as written.
• The SALT deduction saga shows that statutory recharacterizations—like calling tax payments "charitable contributions"—don't guarantee federal deductibility.

Proponents of the reform assert that the IRS must follow New York's statutory characterization. But a closer examination reveals that New York's reform may not work. The IRS may simply reject its attempt to make clawedback gifts deductible for federal estate tax purposes. Recent history shows that state statutes don’t control deductibility—federal law does.

For more information see Hani Sarji "NY Proposal Tries to Make Clawback Tax Deductible—But Will the IRS Agree?" Wills, Trusts, Estates Information, April 15, 2025.