Taxation of Trusts and their Beneficiaries

Starting in 2018, under the new tax package passed by the Republicans at the end of 2017, known as the Tax Cuts and Jobs Act, the tax brackets for 2018 and afterwards have changed slightly. The new brackets are listed at the bottom of this article.

Trusts, like estates, are a taxable entity. A trust is a fiduciary entity whose objective is to hold and invest money or property held in the trust for the benefit of the beneficiaries. Trust property consists of principal (aka corpus), which is the property transferred to the trust by the grantor, and income earned by the trust, usually from investments. If the trust retains income beyond the end of the calendar year, then it must pay taxes on it. If money is distributed to the beneficiaries, then whether it is taxable or not to the beneficiaries will depend on whether principal or income was distributed, and if it was income, then whether it was tax-free income or retained income from previous years that the trust has already paid tax on. Because trusts are not subject to double taxation, either principal or income on which the trust paid taxes can be distributed tax-free to the beneficiaries. Likewise, any taxable distribution to beneficiaries is deductible by the trust.

Gift taxes may also apply to either property transfers to a trust or distributions to beneficiaries. Property transfers to an irrevocable trust may be subject to gift tax, but for revocable trusts, gift tax liability will not be incurred until the property is transferred to a beneficiary or when the trust becomes irrevocable.

A trust must use a calendar year. If the trust has taxable income or gross income of $600 or more, or if any of the beneficiaries are non-resident aliens, then it must file Form 1041, U.S. Income Tax Return for Estates and Trusts and may also have to make estimated tax payments.

A simple trust is required to distribute all its income, and no amount is paid or set aside for charitable contributions. Otherwise, the trust is a complex trust. Capital gains, under most state laws and trust documents, are allocated to corpus.

The complexity of trust taxation arises because of several factors:

Generally, the tax rules that apply to trusts are the same as those that apply to individuals, but the actual calculation is more complex:

  1. calculate trust accounting income;
  2. calculate the tentative taxable income before subtracting the distribution deduction, which is the amount that the trust can deduct because of the distribution;
  3. calculate the distributable net income (DNI) so that the distribution deduction can be calculated and so that tax-free and taxable distributions can be allocated to the beneficiaries;
  4. subtract the distribution deduction from the tentative taxable income to determine trust taxable income;
  5. calculate trust tax liability;
  6. allocate DNI and the distribution deduction to the beneficiaries to determine the character and the amount of income taxed to each beneficiary.

Trust Accounting Income

When a trust earns income or pays expenses, the income or expenses are allocated either to principal or to income. The trust document usually specifies which income or expenses are allocated to the principal or to income. If the trust document does not specify the allocation, then state law applies. Most states have adopted all or part of the Uniform Principal and Income Act (UPIA). The UPIA allocates:

Example: Allocating Income or Expenses to Principal or Income

If a trust has a single beneficiary and:


Trust Tentative Taxable Income

Trust taxable income is determined as it is for individuals. However, a trust does not usually itemize deductions, and a trust also has a personal exemption, which is $300 for trusts required to distribute all their income annually to beneficiaries (simple trusts), $4300, which is not subject to phaseout, for a qualified disability trust, and $100 for all other trusts.

A qualified disability trust is any trust established solely for the benefit of a disabled individual younger than 65, who was determined by the Commissioner of Social Security to have been disabled as defined 42 U.S.C. 1382c(a).

Generally, trust income is defined as income earned from investments, including tax-free income, but does not include capital gains on trust assets. However, taxable income includes all income earned by the trust, including capital gains, minus tax-free income.

Example: How Trust Income Differs from Its Taxable Income

A trust has the following income:


Typical trust expenses include trust administration expenses, expenses for the production of income, depreciation, and charitable contributions. However, expenses for the production of tax-free income are not deductible and depreciation can be claimed either by the trust or by the income beneficiaries or it can be apportioned to both according to the trust document.

Only a complex trust can deduct charitable contributions, but only if the trust document specifically allows it. Charitable deductions are claimed on Form 1041-A, U.S. Information Return for Trust Accumulation of Charitable Amounts.

Example: Allocating Depreciation between the Trust and the Beneficiary

Direct expenses for tax-free income are not deductible, since no taxes are paid on such income. Indirect expenses, which are the expenses of administering the trust, are generally deductible, but if the trust has tax-free income, then a proportion, = tax-free income ÷ trust accounting income, of indirect expenses is not deductible.

Nondeductible Indirect Expense Allocable to Tax-Free Income = Total Indirect Expenses × Tax-Exempt Interest
Accounting Income

Distributable Net Income and the Distribution Deduction

A trust is considered by tax law to be a modified conduit, because usually only some of the income and deductions pass through to the beneficiaries. The trust itself often retains some income, especially capital gains, which is usually allocated to the trust corpus. However, distributions from the trust usually have both taxable and tax-free portions. The tax-free portion of the distribution may result from tax-exempt income, such as the tax-exempt interest earned from municipal bonds, or from retained earnings of the trust on which it has already paid taxes in previous years or from trust principal which is generally not taxable because of the recovery of capital doctrine. In other words, the money or property invested in the trust is the contributed capital, so any distributions from contributed capital are simply distributions of the original investment, and, therefore, not taxable.

Generally, taxes on taxable income must be paid either by the trust or by the beneficiaries, but not both. If the trust retains income beyond year-end, then the trust must pay taxes on it. However, if the income is distributed, then the beneficiaries pay taxes on it and the trust is permitted to deduct it. If the trust accounting income consists of both tax-free and taxable income, then the tax-free and taxable portions of the income distributed must be allocated to each beneficiary. The trust can deduct the taxable portion of the distributions but not the tax-free portion nor any expenses that must be allocated to the tax-free portion of income. To calculate this allocation, an intermediate result must first be calculated, called the distributable net income.

The distributable net income (DNI) sets a ceiling both on the trust distribution deduction and on the amount taxable to the trust beneficiaries. The DNI is used to calculate the trust taxable income, calculate the beneficiaries taxable income, and to characterize distributions to beneficiaries, such as between taxable and tax-free distributions.

Distributable Net Income (DNI) =

The personal exemption is added back to taxable income because, while it is a deduction, it is not an actual expense, and thus, it is available for distribution. Tax-exempt interest is added because it is not includible in taxable income, but it is available for distribution to the beneficiaries. Since the tax-exempt interest is distributed, the expenses allocable to the interest are also subtracted. Capital gains that are allocated to trust principal are subtracted from taxable income because the gains are not distributed to the beneficiaries. For the same reason, capital losses allocated to trust principal are added back, because the losses decrease taxable income, but do not decrease the income available for distribution to the beneficiaries.

Example: How Capital Gains and Losses Affect the Trust Taxable Income and the Distribution to Beneficiaries

The trust issues a Schedule K-1, Beneficiary's Share of Income, Deductions, Credits, etc. of Form 1041, U.S. Income Tax Return for Estates and Trusts to each beneficiary, listing the beneficiary's share of income and deductions. Only taxable income is listed; tax-exempt income is omitted.

The purpose of DNI is to determine what part of a distribution to beneficiaries is taxable to the beneficiary and deductible by the trust. This is achieved by multiplying each type of income, such as rent or dividends, by the total amount distributed divided by the DNI. Capital gains or losses are generally allocated to corpus unless they are distributed to the beneficiaries.

Capital gains and losses are netted out at the trust level. However, beneficiaries cannot deduct any net losses on their return except when the trust is terminated, in which case any unused capital loss carryovers can be used to offset income to the beneficiaries.

The distribution deduction cannot exceed the taxable distribution, since taxes must be paid on taxable income either by the trust or by the beneficiaries. For a complex trust, the distribution deduction can be determined by the following formula:

If Total Distributions > DNI, then:

Distribution Deduction = DNI − Tax-Exempt Income − Expenses Allocable to Tax-Exempt Income

If DNI > Total Distributions, then:

Distribution Deduction = Total Distributions − (Total Distributions × Net Tax-Exempt Income/DNI).

Example: the WCS Trust is required to distribute all income to its sole beneficiary. All capital gains and losses and expenses are allocable to the trust corpus. Income and expenses for the year are listed in the Totals column in the table below. Trust accounting income, trust taxable income, DNI, and the distribution deduction are also calculated in the table below, based on the income and expenses in the Totals column:

Example: Calculating the DNI and the Distribution Deduction
Totals Accounting Income Taxable Income DNI
Taxable Interest $10,000 $10,000 $10,000
Tax-Exempt Interest $15,000 $15,000
Dividend Income $20,000 $20,000 $20,000
Net Long-Term Capital Gains $25,000 $25,000
Fiduciary Fees $6,000 ($4,000)
Personal Exemption ($300)
Corpus Capital Gain/Loss
Income before the
Distribution Deduction
$45,000 $50,700 $50,700
Nondeductible Expense Allocable
to Tax-Free Income
= Fiduciary Fees - (Fiduciary Fees × Tax-Exempt Interest/Accounting Income) ($2,000)
Personal Exemption $300
Corpus Capital Gain/Loss ($25,000)
Tax-Exempt Income $15,000
Distributable Net Income $39,000
Distribution Deduction = DNI − (Tax-Exempt InterestAllocable Expense)
= $39,000 − ($15,000$2000)
= $26,000
Taxable Income for Trust $24,700

Note that in calculating DNI, the personal exemption is added back because it is a statutory deduction, which is not a real expense, so it is available for distribution. Note also that even though the beneficiary receives $30,000 of taxable income, the trust can only deduct $26,000 for the distribution. This is because the trust has already deducted the $4000 fiduciary fee allocable to taxable income to arrive at the tentative taxable income before the distribution deduction. To allow the trust to deduct the full $30,000 would allow the trust to deduct the deductible portion of the fiduciary fee twice.

Trust Taxable Income

Trusts and estates are subject to most of the same tax rules that apply to individuals. They even share some of the same percentage tax brackets, but the boundaries of the tax brackets occur at much lower income levels.

Trust and Estate Capital Gains Tax
Taxable Income (TI) Tax Rate
2023: Rev. Proc. 2022-38
$0 < TI ≤ $3,000 0%
$2,800 < TI ≤ $14,650 15%
$14,650 < TI   20%
2022: Revenue Procedure 2021-45
$0 < TI ≤ $2,800 0%
$2,800 < TI ≤ $13,700 15%
$13,700 < TI   20%
2021: Revenue Procedure 2020-45
$0 < TI ≤ $2,700 0%
$2,800 < TI ≤ $13,250 15%
$13,250 < TI   20%
Trust and Estate Tax Table
Taxable Income (TI) Tax Rate
2023: Rev. Proc. 2022-38
$0 < TI ≤ $2,900 10%
$2,750 < TI ≤ $10,550 24%
$9,850 < TI ≤ $14,450 35%
$14,450 < TI 37%
2022: Revenue Procedure 2021-45
$0 < TI ≤ $2,750 10%
$2,750 < TI ≤ $9,850 24%
$9,850 < TI ≤ $13,450 35%
$13,450 < TI 37%
2021: Revenue Procedure 2020-45
$0 < TI ≤ $2,650 10%
$2,650 < TI ≤ $9,550 24%
$9,550 < TI ≤ $13,050 35%
$13,050 < TI 37%
2020: Revenue Procedure 2019-44
$0 < TI ≤ $2,600 10%
$2,600 < TI ≤ $9,450 24%
$9,300 < TI ≤ $12,950 35%
$12,950 < TI 37%

Example: Calculating the Tax on Trust Income

If trust taxable income = $15,000 for 2019, then:

Trust Taxable Income $15,000
Top Tax Bracket $12,750
Top Bracket Base Tax $3,075.50
Income Taxed at 37% $2,250.00
37% Tax $832.50
Tax on Undistributed Income (Base Tax + 37% Tax) $3,966.50
Tax on Income Distributed to a 12% Bracket Beneficiary $1,800.00

As you can see in the last row of the above table, if the $15,000 is distributed to a beneficiary who earned only an additional $20,000 from work, then the $15,000 will be subject only to the beneficiary's 12% marginal tax rate, for a total tax of $1800 instead of the trust tax of $3966.50.

Trusts may also be subject to the alternative minimum tax, but this is usually easy to avoid.

2013 Tax Changes

Tax changes enacted in 2013 included a top tax bracket for trusts of 39.6% on undistributed income, adjusted for inflation (latest year amount is shown in the above tax table for trusts) and increases the long-term capital gains rate from 15% to 20% for the top tax bracket. The Tax Cuts and Jobs Act has lowered the top rate to 37%.

Trusts are also subject to the Net Investment Income Tax (NIIT), sometimes called the Obamacare tax, of 3.8% on undistributed investment income exceeding the threshold for the top marginal rate for trusts. By contrast, the NIIT only applies to individuals earning a minimum of $200,000 ($250,000 for a couple filing jointly). Hence, the total tax on undistributed capital gains in the top bracket will be 23.8%. However, the following types of trusts are not subject to the NIIT:

Taxation of Trust Beneficiaries

The trust is only permitted to deduct distributions taxable to the beneficiaries. Therefore, the total amount taxable to all trust beneficiaries cannot be less than the distribution deduction claimed by the trust. Total distributions to beneficiaries will exceed the distribution deduction if a portion of the distribution consists of tax-exempt income, income on which the trust has already paid tax on, principal, which is not subject to taxation, or if there were deductible expenses allocated to corpus, and deducted to arrive at the tentative taxable income before the deduction of the distribution deduction. Multiple beneficiaries are taxed proportionately on their share of taxable amounts distributed.

Example: How to Calculate the Taxable Portion of Distributions to Beneficiaries

Naturally, the taxation of complex trusts is more complex. The distributions are divided into what are called first-tier distributions and second-tier distributions. First-tier distributions are required distributions from trust income, which is stipulated in the trust document; the remaining distributions are second-tier distributions. If all distributions are within either the first- or second-tier, then the taxation of beneficiaries is calculated as it is for simple trusts. However, if there is more than one level of distributions, then the taxability of beneficiary income depends on the following rules:

First-Tier Beneficiary
Taxable Income
= Taxable DNI
Total DNI
× First-Tier Distribution
to the Beneficiary
Second-Tier Beneficiary
Taxable Income
= Taxable DNI
Total DNI
× Second-Tier Distribution
to the Beneficiary
Total Second-Tier Distribution
× Remaining DNI after

Example: Allocating DNI to First- and Second-Tier Distributions

The ABC Trust has 2 beneficiaries: Amy and John, and none of the trust's income is from tax-free interest.

Case #1:

Case #2:

Same as Case #1, except that DNI = $40,000, and the required distribution to John is $30,000.

Case #3:

Trust Income $70,000
DNI $60,000
Amount Required to be Distributed to Amy $15,000
Allocation of DNI to First-Tier Distributions
to Amy $15,000
to John $0
Remaining DNI to be Distributed $45,000 = DNI - First-Tier Distributions
Second-Tier Distributions
to Amy $30,000
to John $40,000
Total Second-Tier Distributions $70,000
Allocation of DNI to Second-Tier Distribution
to Amy $19,286 = Remaining DNI × Distribution /Total Second-Tier Distribution
to John $25,714 = Remaining DNI × Distribution /Total Second-Tier Distribution
Income Taxable to Beneficiaries
to Amy $34,286 = Total Allocated DNI
to John $25,714 = Total Allocated DNI
Total Taxable Income to Beneficiaries = $60,000 = Total Distributed DNI = Distribution Deduction

Note that the last statement is only true because there was no tax-exempt income.

If portions of taxable income differ in character, such as some being capital gains and some being ordinary income, then the character is assigned proportionately to the taxable distribution amounts using the same order as for first-tier and second-tier distributions.

A separate share rule may also apply if the trust is administered as separate shares according to the trust document. In this case, DNI is determined as if the shares are treated as separate estates or trusts in computing DNI allocable to the beneficiaries. The separate share rule generally applies to 1 trust; it does not apply to multiple trusts created by a single trust instrument. However, the separate share rule does not increase the number of deductions available to the trust nor does it increase the number of personal exemptions nor can the income be split so that it is taxed at lower rates.

Trust Property Distributions

Trust property distributions are based on the adjusted tax basis of the property rather than its fair market value (FMV) when it is distributed. The beneficiary's basis in the property = the carryover basis of the trust, and the beneficiary's holding period for the property includes the holding period for the trust.

However, the trustee can elect to recognize gains or losses on the distribution of appreciated property if the trust has other losses or gains that can be offset by the election. If so, then the contribution to the distribution deduction will be equal to the property's FMV on the distribution date and the beneficiary's tax basis will be equal to the FMV and the beneficiary's holding period will begin on the distribution date.

Trust Termination

When a trust terminates, it must distribute all its income and property to the beneficiaries. Therefore, even a simple trust must necessarily be a complex trust in its final year of existence, since it must distribute both income and principal. If the trust has operating losses that cause it to have a negative taxable income, then the proportion of the net loss to each beneficiary can be deducted as an itemized deduction on each beneficiary's return. If the trust also has capital loss carryovers, then these carryovers will be distributed to the beneficiaries in the same proportion as the final distributions from the trust. 

Historical Notes

Trust and Estate Tax Table
Taxable Income (TI) Tax Liability
Base Tax Additional Tax
2021: Revenue Procedure 2020-45
$0 < TI ≤ $2,650 $0 + 10% × TI
$2,650 < TI ≤ $9,550 $265 + 24% × (TI − $2,650)
$9,550 < TI ≤ $13,050 $1,921 + 35% × (TI − $9,550)
$13,050 < TI $3,146 + 37% × (TI − $13,050)
2020: Revenue Procedure 2019-44
$0 < TI ≤ $2,600 $0 + 10% × TI
$2,600 < TI ≤ $9,450 $260 + 24% × (TI − $2,600)
$9,300 < TI ≤ $12,950 $1,904 + 35% × (TI − $9,450)
$12,950 < TI $3,129 + 37% × (TI − $12,950)
2019:: Rev. Proc. 2016-55Rev. Proc. 2016-55
$0 < TI ≤ $2,600 $0 + 10% × TI
$2,600 < TI ≤ $9,300 $260 + 24% × (TI − $2,600)
$9,300 < TI ≤ $12,750 $1,868 + 35% × (TI − $9,300)
$12,750 < TI $3,075.50 + 37% × (TI − $12,750)
2018:New Republican Tax Plan
Brackets (Tax Cuts and Jobs Act)
This new bracket also applies to
unearned income subject to the kiddie tax.
$0 < TI ≤ $2,550 $0 + 10% × TI
$2,550 < TI ≤ $9,150 $255 + 24% × (TI − $2,550)
$9,150 < TI ≤ $12,500 $1,839 + 35% × (TI − $5,950)
$12,500 < TI $3,011.50 + 37% × (TI − $12,500)
2018: Rev. Proc. 2017-58
$0 < TI ≤ $2,600 $0 + 15% × TI
$2,600 < TI ≤ $6,100 $390 + 25% × (TI − $2,550)
$6,100 < TI ≤ $9,300 $1,265 + 28% × (TI − $5,950)
$9,300 < TI ≤ $12,700 $2,161 + 33% × (TI − $9,050)
$12,700 < TI $3,283 + 39.6% × (TI − $12,400)
2017: Rev. Proc. 2016-55
$0 < TI ≤ $2,550 $0 + 15% × TI
$2,550 < TI ≤ $6,000 $382.50 + 25% × (TI − $2,550)
$6,000 < TI ≤ $9,150 $1,245 + 28% × (TI − $5,950)
$9,150 < TI ≤ $12,500 $2,127 + 33% × (TI − $9,050)
$12,500 < TI $3,232.50 + 39.6% × (TI − $12,400)
$0 < TI ≤ $2,550 $0 + 15% × TI
$2,550 < TI ≤ $5,950 $382.50 + 25% × (TI − $2,550)
$5,950 < TI ≤ $9,050 $1,232.50 + 28% × (TI − $5,950)
$9,050 < TI ≤ $12,400 $2,100.50 + 33% × (TI − $9,050)
$12,400 < TI $3,206 + 39.6% × (TI − $12,400)
$0 < TI ≤ $2,500 $0 + 15% × TI
$2,500 < TI ≤ $5,900 $375 + 25% × (TI − $2,500)
$5,900 < TI ≤ $9,050 $1,225 + 28% × (TI − $5,900)
$9,050 < TI ≤ $12,300 $2,107 + 33% × (TI − $9,050)
$12,300 < TI $3,179.50 + 39.6% × (TI − $12,300)
$0 < TI ≤ $2,500 $0 + 15% × TI
$2,500 < TI ≤ $5,800 $375 + 25% × (TI − $2,500)
$5,800 < TI ≤ $8,900 $1,200 + 28% × (TI − $5,800)
$8,900 < TI ≤ $12,150 $2,068 + 33% × (TI − $8,900)
$12,150 < TI $3,140.50 + 39.6% × (TI − $12,150)
$0 < TI ≤ $2,400 $0 + 15% × TI
$2,450 < TI ≤ $5,700 $367.50 + 25% × (TI − $2,450)
$5,700 < TI ≤ $8,750 $1,180 + 28% × (TI − $5,700)
$8,750 < TI ≤ $11,950 $2,034 + 33% × (TI − $8,750)
$11,950 < TI $3,090 + 39.6% × (TI − $11,950)
$0 < TI ≤ $2,400 $0 + 15% × TI
$2,400 < TI ≤ $5,600 $360 + 25% × (TI − $2,400)
$5,600 < TI ≤ $8,500 $1,160 + 28% × (TI − $5,600)
$8,500 < TI ≤ $11,650 $1,972 + 33% × (TI − $8,500)
$11,650 < TI $3,012 + 35% × (TI − $11,650)