Do Trusts Get Taxed? How Trust Taxation Works

Trusts are subject to taxation, but who pays depends on the trust’s structure. The tax liability can fall to the person who created it (the grantor), the trust itself, or the beneficiaries who receive distributions. The rules for determining the responsible party consider who has control over the assets and whether income is held within the trust or distributed. This determines if the trust operates as its own tax-paying entity or if the tax obligations pass to individuals.

Determining Who Pays the Tax

The primary distinction for tax purposes is whether a trust is a grantor or non-grantor trust. A grantor trust is most often revocable, meaning the grantor—the person who created it—retains the power to change or cancel the trust. For tax purposes, the IRS essentially disregards a grantor trust as a separate entity. All income, deductions, and credits are reported directly on the grantor’s personal income tax return, Form 1040. Since the grantor has not truly relinquished control, the trust may use the grantor’s Social Security Number for reporting purposes.

In contrast, a non-grantor trust is an irrevocable trust where the grantor has permanently given up control over the assets. When a trust is irrevocable and does not meet any specific grantor trust definitions, it is treated as a separate taxable entity. This means the trust must obtain its own Taxpayer Identification Number (TIN) and is responsible for paying taxes on any income it earns and does not distribute. While most irrevocable trusts are non-grantor trusts, certain powers retained by the grantor can cause an irrevocable trust to be classified as a grantor trust for income tax purposes.

Calculating a Trust’s Income Tax

The calculation of a non-grantor trust’s income tax liability centers on a concept known as Distributable Net Income (DNI). DNI represents the trust’s income that is available for distribution to beneficiaries. The trust receives a tax deduction for the income it distributes, but this deduction cannot exceed the DNI for the year. This mechanism effectively allocates the tax liability between the trust and its beneficiaries, ensuring income is taxed only once.

Any taxable income a non-grantor trust earns but does not distribute to beneficiaries is taxed directly at the trust level. The calculation starts with the trust’s total income, such as interest and dividends, and subtracts allowable deductions like trustee fees and tax preparation costs. Capital gains are generally excluded from the DNI calculation and are taxed to the trust, as they are considered an addition to the principal rather than income.

The federal income tax brackets for trusts are highly compressed. For the 2025 tax year, a trust reaches the top marginal rate of 37% on income over just $15,650. This is a stark contrast to the brackets for individual taxpayers; for single filers, the 37% bracket applies to income over $626,350. This rapid acceleration to the highest tax rate makes accumulating income within a trust a potentially expensive tax strategy.

The tax rules also differentiate between simple and complex trusts. A simple trust is one that is required to distribute all of its income annually. A complex trust is permitted to accumulate income, distribute principal, and make charitable contributions. This classification affects some reporting requirements but operates within the same DNI framework.

Information Required for Trust Tax Filings

A non-grantor trust must obtain a Taxpayer Identification Number (TIN), also known as an Employer Identification Number (EIN), from the IRS. Since a non-grantor trust is a separate taxable entity, it cannot use the grantor’s or trustee’s Social Security Number. This EIN must be used on all tax filings and is required by financial institutions to open accounts in the trust’s name. Throughout the year, the trustee must track all financial transactions.

The primary information needed for the tax return includes:

• All forms of income, such as interest, dividends, rental income, and any capital gains from asset sales.
• All deductible expenses, including trustee fees, professional fees for accountants and lawyers, and other administrative costs.
• A precise record of every distribution made to each beneficiary, including the date and amount.
• Each beneficiary’s legal name, address, and Social Security Number.

This collected data is used to complete the primary tax form, Form 1041, the U.S. Income Tax Return for Estates and Trusts. From the information on Form 1041, the trustee generates a Schedule K-1 for each beneficiary who received a distribution. The Schedule K-1 reports that specific beneficiary’s share of the trust’s income, which they must then report on their personal tax return.

The Trust Tax Filing and Reporting Process

For most trusts, the tax year aligns with the calendar year, making the filing deadline April 15th. A trustee can file for an extension, which pushes back the deadline to submit the forms but not the deadline to pay any tax due.

After Form 1041 is prepared, a Schedule K-1 must be sent to every beneficiary who received an income distribution during the tax year. This form details the amount and character of income the beneficiary is responsible for reporting on their own tax return.

If the trust retained income and owes federal income tax, the payment must be made. This can be done through quarterly estimated tax payments, particularly if the trust is expected to owe $1,000 or more in tax. Any remaining balance is paid when the Form 1041 is filed.

Interaction with Gift and Estate Taxes

Beyond income tax, creating and funding a trust can have implications for federal gift and estate taxes. When a grantor transfers assets into an irrevocable trust, that transfer is considered a taxable gift. For 2025, an individual can give up to $19,000 to any number of individuals, including trusts, without incurring gift tax or filing a gift tax return; this is the annual gift tax exclusion. If contributions to a trust for a single beneficiary exceed this amount, the grantor must file Form 709, United States Gift Tax Return.

Filing a gift tax return does not automatically mean tax is due, as any gift amount over the annual exclusion is applied against the grantor’s lifetime gift and estate tax exemption. For 2025, this unified exemption is $13.99 million per individual. Under current law, this increased exemption amount is scheduled to sunset at the end of 2025, reverting to its pre-2018 level of approximately $5 million (adjusted for inflation) on January 1, 2026. The responsibility for any gift tax lies with the donor, not the trust or its beneficiaries.

The type of trust also affects the grantor’s taxable estate at death. Assets held in a revocable trust are included in the grantor’s gross estate because the grantor retained control. Conversely, one motivation for creating an irrevocable trust is to remove assets from the grantor’s taxable estate. If structured properly, assets transferred to an irrevocable trust, along with any future appreciation, are not subject to estate tax upon the grantor’s death.