Retained vs. distributed
Income that stays in the trust is taxed to the trust. Income distributed out is generally taxed to the beneficiary instead.
Key takeaways
The compression is severe
A trust hits 37% at $16,000 of retained income for 2026. A single individual does not reach it until $640,600.
DNI is the ceiling
Distributable net income caps what the trust deducts and what the beneficiary is taxed on. Miss it and the same dollar is taxed twice.
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The mechanism
Trusts are separate entities on the most compressed rate schedule in the code
Trusts are taxed as separate entities, and the rate schedule they get is the most compressed in the tax code.
The mechanism that moves the tax is the distribution deduction. What the trust distributes it deducts on Form 1041, and the beneficiary reports it on a Schedule K-1 instead.
012026 rate schedule
Trust income tax rates for 2026
These are the 2026 rates for a trust. The bracket compression is why almost every distribution decision goes the way it does.
| Trust taxable income, 2026 | Rate |
|---|---|
| Up to $3,300 | 10% |
| $3,300 to $11,700 | 24% |
| $11,700 to $16,000 | 35% |
| Over $16,000 | 37% |
A single individual does not reach 37 percent until $640,600, which is the whole reason distributing is usually better than accumulating.
On 2026 rates, $50,000 of ordinary income retained in a trust carries about $5,400 more tax than the same income distributed to a beneficiary whose marginal rate is 22 percent, assuming the beneficiary has room in that bracket to absorb it.
Retained in the trust
≈ $16,400
$50,000 kept inside the trust and taxed at the compressed rates.
Distributed at beneficiary 22%
≈ $11,000
Same $50,000 pushed out to a beneficiary whose marginal rate is 22 percent.
Difference
≈ $5,400
About 10.8% of the income, moved by one decision.
02Type of trust
Simple trusts and complex trusts
Whether a trust is simple or complex is decided each year by what it actually did, so the answer can change from one year to the next.
Simple trust
Must distribute all of its income currently, cannot make charitable gifts, and cannot distribute principal. The income is taxed to the beneficiaries whether or not the cash moved. Income here means fiduciary accounting income, set by the deed and by state law — not the same figure as taxable income or as DNI.
Complex trust
Everything else. It can accumulate income, distribute principal, or give to charity, and the trustee usually has discretion over which.
Grantor trust
Works differently. Its income is taxed to the person who created it, at their own rates, and the compressed brackets never come into it. Setting one up is a separate question from taxing it.
03DNI
Distributable net income — the ceiling on everything
DNI does three jobs, and the first two are the same figure applied from each side.
Caps the trust’s deduction
The trust cannot deduct more than DNI, however much cash it paid out.
Caps the beneficiary’s income
The beneficiary is not taxed on more than their share of DNI, even if they received more.
Carries character through
Interest stays interest, qualified dividends stay qualified dividends, and tax-exempt interest stays tax-exempt. Distributions do not convert one kind of income into another.
Capital gains usually stay in the trust
Most deeds and most state laws allocate capital gains to principal rather than to income, which keeps them out of DNI. A trust can distribute all of its cash and still pay 37% on the gains, because for tax purposes the gains never left.
Amounts distributed beyond DNI are generally principal, and principal is not taxed again on the way out. The trust already paid tax on it, or it was never income in the first place. Where the trust arises from a death, the estate tax return is a separate filing.
04Multiple beneficiaries
Who gets taxed first
Where a trust distributes to more than one beneficiary, the rules work in tiers. Amounts required to be distributed come first and they absorb DNI before anything discretionary does. Discretionary distributions take what is left.
It matters when DNI is smaller than the total distributed, because the beneficiaries do not share the tax proportionally. The one with a mandatory income interest can be taxed on all of it while another receives cash and reports nothing.
05Section 663(b)
The 65-day election — a two-month look-back for a trustee
A trustee can make a distribution in the first 65 days of a year and elect to treat it as made on the last day of the year before.
65
days
The election lets a trustee look at a year that has closed, see what income was retained, compare the trust brackets against the beneficiaries, and then act.
It is an election, so it has to be made on a timely filed Form 1041, and it is only available to complex trusts and estates. Trusts are almost always on a calendar year, so the window closes in early March. A trustee who waits until the return is being prepared in September has already missed it.
06For the trustee
What the compressed brackets mean for a trustee
Step 01
Compare brackets before year end
The question is never what the trust’s rate is. It is whether the beneficiary’s rate is lower.
Step 02
Watch the surtax separately
The 3.8% net investment income surtax hits a trust at $16,000 for 2026 — the same point the 37% bracket opens. Retained investment income can face 40.8%. A beneficiary may be nowhere near their own threshold.
Step 03
Read the deed before the tax rules
Saving tax is not on its own a reason to distribute. The instrument decides what is permitted, and fiduciary duty decides what is appropriate.
Step 04
Remember the beneficiary
Pushing income out lowers the total bill but raises somebody’s personal return, and it can affect their own thresholds and credits. The right answer accounts for the whole family, not just the trust’s return.
Year end approaching? Send us the trust income and a picture of the beneficiaries and we will tell you whether a distribution beats accumulating.
07FAQ
Trustee questions on distributions and DNI
Who pays tax on a trust distribution, the trustee or the beneficiary?
Usually the beneficiary, capped at their share of distributable net income. Anything retained inside the trust is taxed to the trust at its own compressed rates.
What is the 65 day rule for trusts?
It backdates an early payment into the prior tax year. The window shuts in early March for a calendar year trust, and only complex trusts and estates may use it.
Do trusts pay a higher tax rate than individuals?
Yes, at nearly every level of retained income. On 2026 figures the top bracket opens at $16,000 for a trust and at $640,600 for an unmarried individual.
How are trust capital gains taxed?
For 2026 it is zero up to $3,300 of taxable income, 15% up to $16,250, and 20% beyond that. The 20% band opens just past the $16,000 ordinary income threshold.
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From the record
On estate planning, and on getting complex questions right
“You’ve already paid tax on this money when you are earning it actively, and then all of a sudden it gets taxed again when it goes to your child or your grandchild or whoever it’s going to. So proper estate planning is very important.”
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Estate attorney
Review the trust before year end
One consultation before December 31 usually saves more than it costs
Send us the trust’s income for the year and a rough picture of the beneficiaries. We will compare the brackets and tell you whether a distribution or a 65-day election is worth making. Call (212) 641-0673 or send the contact form. No charge for the conversation.
Reviewed by George Dimov, CPA, New York, NY. Serving clients in all 50 states, 15+ years advising New York businesses and individuals. President of George Dimov, CPA, a New York City firm serving clients across the five boroughs and nationwide.