Trust Modifications: How They Impact Business Valuation and Tax Planning

Part of Redwood Valuation’s 59th Heckerling Institute Coverage

Irrevocable trusts may not be as “set in stone” as their name suggests. Thanks to modern tools like nonjudicial settlement agreements (NJSAs) and trust decanting, estate planners now have far more flexibility to adapt existing trusts to changing legal, tax, or family circumstances, without going to court.

But this flexibility comes with a caveat: modifying a trust, especially one that holds a business interest, can introduce significant valuation and tax complexities. The session, But I Thought It Was Irrevocable? at the 59th Heckerling Institute explored exactly that: how and why planners are using these tools and what trustees and valuation professionals need to consider along the way.

What’s Changing: The Rise of Flexible Trust Modification Tools

Historically, modifying an irrevocable trust required judicial approval, making it a slow, costly process. However, there’s been a surge in planners relying more on NJSAs and trust decanting to allow for private resolution. NJSAs are agreements between all trustees that allow parties to clarify or amend terms without going to court. Trust decanting is a mechanism for transferring assets from one trust into a newly drafted trust with different terms to modernize outdated provisions. 

These approaches help trustees and beneficiaries adapt to new or changing laws, family needs, or planning objectives. But when business interests are involved, they can affect how those assets are valued and taxed.

Why Valuation Professionals Need to Be Involved

Trust modifications aren’t just administrative, they can materially alter the rights associated with trust assets and, in turn, affect their economic value and risk profile. These changes can have a direct impact on how these assets are valued for gift and estate tax purposes, particularly in the context of fair market value. Here are three key valuation risks to be aware of when a trust is modified:

1. Discounts May Change

Many trusts hold interests in closely held entities where discounts for lack of control and marketability are critical to the valuation. If a modification changes voting rights, control provisions, or the trust’s ability to liquidate assets, those discounts may no longer apply. Experts should closely examine whether the trust modification inadvertently undermines prior valuation positions.

2. Shifts in Beneficial Interests May Trigger Taxable Events

Modifications that adjust beneficial interests, such as reallocating shares among beneficiaries or adding a generation-skipping component, could trigger taxable events. Without careful valuation and tax coordination, what seems like a simple administrative update could carry unintended consequences.

3. IRS Scrutiny and Documentation Risk

The IRS closely reviews trust modifications that appear to shift tax burdens or valuation outcomes. Inconsistent documentation, retroactive changes, or unsubstantiated valuation adjustments may evoke audit scrutiny. That’s why it’s essential to ensure existing valuation reports clearly align with the new trust structure.

The Winning Formula: A Proactive, Cross-Disciplinary Approach

As trust modifications become more common, they also require a more deliberate process—one that brings legal, tax, and valuation experts together. Here’s how to stay ahead:

• Involve valuation professionals early. Don’t wait until after the modification is complete. Assessing valuation risk before the modification can help avoid surprises.

• Be sure to reassess discounts after the modification. Even slight changes to trustee powers, voting rights, or distribution terms can have a meaningful impact on value.

• Document every step. IRS scrutiny is increasing. A clear paper trail explaining the reason for the modification, how it impacts value, and how that value was determined is critical.

• Coordinate across disciplines. Estate attorneys, CPAs, and valuation professionals should work in tandem to ensure modifications align with planning goals without introducing valuation inconsistencies or triggering taxable events.

Redwood Can Help

Trust modifications are a powerful estate planning tool, but they’re not without risk. At Redwood Valuation, we specialize in complex valuations involving closely held businesses and dynamic trust structures. Whether you’re using an NJSA to modernize an existing trust or exploring a full decanting strategy, our team delivers technically sound, audit-ready valuations designed to stand up under scrutiny.

We help estate planners and trustees stay ahead of valuation risks so trust modifications do what they’re supposed to do: provide flexibility, not confusion.