NY Estate Tax: Why Clawed-Back Gifts Don’t Get a Basis Step-Up

In today’s T&E Think Tank Zoom study session, hosted by Linda Maryanov, a fascinating point arose regarding New York estate tax law. The question was whether gifts made within three years of the decedent’s death, which are clawed back into the New York gross estate for estate tax purposes under New York Tax Law § 954(a)(3), receive a basis adjustment at the decedent’s death.

Key Takeaway: Gifts clawed back into the New York estate for tax purposes do not receive a basis adjustment at the decedent’s death.

The New York Clawback Rule

New York's estate tax law includes a provision that certain gifts made within three years of the decedent's death are pulled back into the decedent's gross estate for the purpose of calculating the New York estate tax. Specifically, under New York Tax Law § 954(a)(3), such gifts are subject to state estate tax, even though New York does not have a separate gift tax.

For instance, if a New York resident gifts $500,000 in appreciated stock to a beneficiary shortly before passing, that gift will be included in the gross estate for New York estate tax purposes but won’t receive an income tax basis step-up.

The intent behind the rule is to prevent individuals from avoiding New York estate tax by making substantial gifts shortly before death.

Basis Adjustment and Federal Law

The analysis gets interesting when we look at basis adjustments. Under federal tax law, IRC § 1014 provides that property included in a decedent's federal gross estate generally receives a step-up (or step-down) in basis to the fair market value as of the decedent’s date of death. This allows beneficiaries to potentially sell inherited assets without realizing significant capital gains.

However, the New York clawback rule does not change the federal tax treatment of these gifts. Since the clawed-back gifts are not included in the federal gross estate, they do not benefit from the federal basis adjustment under IRC § 1014. The donee retains the original donor’s adjusted basis in the gifted property, potentially exposing the donee to larger capital gains when the property is eventually sold.

Without the federal basis step-up, the beneficiary could be taxed on capital gains when selling the gifted property, based on the original cost basis, which may be significantly lower than the market value at the decedent’s death. In contrast, assets included in the federal estate would allow for a step-up in basis, reducing or even eliminating capital gains tax liability.

Why No Direct Authority?

While this conclusion seems logically supported by both New York and federal statutes, finding explicit authority that directly confirms this point has proven difficult. The law is clear that the clawback applies only for New York estate tax purposes, but there is no specific ruling or advisory opinion that I could find that addresses whether the gifts get a basis adjustment. This absence of direct authority might be due to the distinct separation between state estate tax inclusion and federal estate inclusion, with the latter being the trigger for basis adjustments.

A Big Thank You

Thanks to the members of the T&E Think Tank, especially for today’s discussion, which clarified this important point and raised such a nuanced issue in the first place.

This topic highlights how New York's estate tax rules interact with federal tax laws in ways that can impact estate planning decisions and the potential tax liability of beneficiaries.

Final Thoughts

For anyone engaged in New York estate planning, it is essential to recognize that the clawback rule impacts New York estate tax but not tax basis adjustments. This distinction may have significant tax consequences for donees, making the timing of gifts a critical aspect of estate planning.