Do You Have to Pay Taxes on Money Inherited From a Trust?

Receiving an inheritance from a trust raises questions about tax obligations. The answer depends on the trust’s structure and the nature of the money or property you receive. Tax liability hinges on whether you are receiving the trust’s original assets, known as principal, or the income those assets have generated. Understanding this distinction is the first step in determining what taxes you might owe.

How Trusts are Taxed

A trust is a legal entity that owns assets and can generate income from sources like interest, dividends, or rent. When a trust earns income, it may be required to file an annual tax return with the IRS using Form 1041, the U.S. Income Tax Return for Estates and Trusts.

A key concept in trust taxation is “Distributable Net Income,” or DNI. DNI is the trust’s taxable income available for distribution to beneficiaries after accounting for deductions like trustee fees. The DNI calculation sets a limit on the amount of income the trust can pass on to its beneficiaries for tax purposes. This mechanism ensures that the same income is not taxed at both the trust and beneficiary levels.

If a trust earns income but does not distribute it to the beneficiaries, the trust itself is responsible for paying the income tax on those retained earnings. Trust tax brackets are highly compressed, meaning they reach the top federal tax rate at a much lower income level than individual taxpayers. For 2025, a trust hits the highest 37% tax bracket on income over $15,650. This structure often incentivizes trustees to distribute income to beneficiaries, who may be in lower personal tax brackets.

Taxation of Distributions to Beneficiaries

A primary factor determining a beneficiary’s tax liability is the distinction between receiving the trust’s principal versus its income. The principal, or corpus, is the original assets used to fund the trust. A distribution of this principal is considered a tax-free inheritance.

In contrast, when you receive a distribution of the income that the trust’s assets have generated, that money is taxable to you. This is the “pass-through” nature of trust taxation where the income flows from the trust to the beneficiary, and the tax liability flows with it. For example, if a trust with corporate bonds generates $10,000 in interest and distributes it to you, you must report that interest income on your personal tax return.

IRS rules determine the source of a distribution. Any payment made to a beneficiary is considered to have come from the trust’s current-year income first. If the distribution amount exceeds the trust’s income for that year, the excess portion is then treated as a non-taxable distribution of principal. For instance, if a trust earned $5,000 in income but distributed $15,000 to you, the first $5,000 would be taxable income, while the remaining $10,000 would be a tax-free return of principal.

The Role of Cost Basis in Inherited Trust Assets

When you inherit non-cash assets like stocks or real estate from a trust, their “cost basis” becomes a factor for your future tax liability. Cost basis is the original purchase price of an asset. When you sell that asset, you pay capital gains tax on the difference between the sale price and the basis. The rules for determining the basis of inherited assets depend on the type of trust.

For assets inherited from a revocable trust upon the grantor’s death, the beneficiary receives a “step-up in basis.” This means the asset’s cost basis is adjusted to its fair market value on the date of the grantor’s death. For example, if stock bought for $10,000 was worth $100,000 when the grantor died, your new basis is $100,000. If you were to sell it immediately for that price, you would have no capital gain and owe no capital gains tax.

The situation can be different for assets received from certain irrevocable trusts. In some cases, if the asset was gifted to the trust during the grantor’s lifetime and is not included in their taxable estate, the beneficiary may receive a “carryover basis.” This means you inherit the grantor’s original cost basis. Using the previous example, if you inherited the stock with a carryover basis of $10,000 and sold it for $100,000, you would have a taxable capital gain of $90,000. The IRS has confirmed that assets in an irrevocable trust that are outside the grantor’s taxable estate do not receive a step-up in basis.

State-Level Taxes on Trust Inheritances

Beyond federal taxes, beneficiaries must also consider potential state-level taxes. The federal government does not have an inheritance tax, but a handful of states do. An inheritance tax is paid by the person who receives the assets, and the tax rate often depends on the beneficiary’s relationship to the decedent. As of 2025, the states that impose an inheritance tax are:

• Kentucky
• Maryland
• Nebraska
• New Jersey
• Pennsylvania

An estate tax is different, as it is levied on the total value of a person’s estate before distribution. While the federal estate tax has a high exemption, some states and the District of Columbia have their own estate taxes with lower exemption thresholds. Maryland is unique as it imposes both an inheritance tax and an estate tax. These jurisdictions include:

• Connecticut
• District of Columbia
• Hawaii
• Illinois
• Maine
• Maryland
• Massachusetts
• Minnesota
• New York
• Oregon
• Rhode Island
• Vermont
• Washington

The rules and exemption amounts for these state taxes vary and are subject to change. Whether a trust inheritance is subject to these taxes can depend on several factors, including the beneficiary’s state of residence, the state where the trust is administered, and the location of trust assets. Beneficiaries should investigate the specific tax laws of the relevant states to determine their obligations.

Reporting Trust Income on Your Tax Return

If you receive taxable income from a trust, the trustee is responsible for providing you with a tax document called a Schedule K-1 (Form 1041). The trustee files Form 1041 with the IRS to report the trust’s financial activity and issues a Schedule K-1 to each beneficiary who has received a distribution of income. This form is needed to prepare your personal income tax return.

The Schedule K-1 details your specific share of the trust’s income, deductions, and credits for the tax year. It breaks down the income by character, such as interest, ordinary dividends, and capital gains. For example, Box 1 of the K-1 will show your share of interest income, while Box 2a will show ordinary dividends. This information is provided because different types of income are taxed at different rates.

When you file your Form 1040 tax return, you will use the information from the Schedule K-1 to report the income. The amounts from the various boxes on the K-1 correspond to specific lines and schedules on your Form 1040. For instance, interest from Box 1 is reported on Form 1040, and capital gains are reported on Schedule D. You do not need to attach the K-1 to your return, but you should keep it for your records.