Yes, trust funds are taxed. Who writes the check depends on the type of trust: a grantor trust passes its income through to the person who created it, while a non-grantor trust is its own taxpayer and hits the top 37 percent federal rate on income above just $16,000 in 2026. When a non-grantor trust distributes income to beneficiaries, the tax bill follows the money to them.
Grantor Trusts and Non-Grantor Trusts Are Taxed Differently
The first question is whether the IRS treats the trust as a separate taxpayer at all. A grantor trust is one where the person who set it up kept enough control that the IRS looks through it. That happens when the grantor holds a reversionary interest worth more than 5 percent of the trust’s value, or keeps the power to revoke the trust and take the assets back.1Office of the Law Revision Counsel. 26 U.S.C. 673 – Reversionary Interests2Office of the Law Revision Counsel. 26 U.S.C. 676 – Power to Revoke Most revocable living trusts fit here. All the trust’s income lands on the grantor’s personal Form 1040 and is taxed at individual rates.
A non-grantor trust, usually an irrevocable trust where the grantor has given up control, is its own taxpayer. The trustee gets a separate employer identification number and files Form 1041 each year the trust has at least $600 in gross income or any taxable income at all.3Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1 The trust pays tax on income it keeps. Income it distributes is deducted from its own return and taxed to the beneficiaries instead, so the same dollar is never taxed twice.
2026 Federal Tax Brackets for Trusts
Non-grantor trusts use a highly compressed set of brackets. They reach the top federal rate at income levels an individual filer would barely notice. For 2026:4IRS. 2026 Form 1041-ES Estimated Income Tax for Estates and Trusts
- 10 percent on taxable income up to $3,300
- 24 percent from $3,300 to $11,700
- 35 percent from $11,700 to $16,000
- 37 percent above $16,000
An individual filer doesn’t reach 37 percent until well past $600,000 in taxable income. A trust gets there at $16,000. That gap is the reason trustees so often push income out to beneficiaries who sit in lower brackets.
The 3.8 Percent Net Investment Income Tax
On top of ordinary income tax, a trust owes a 3.8 percent surtax on the lesser of its undistributed net investment income or the amount by which its adjusted gross income exceeds the threshold where the top ordinary bracket starts.5Office of the Law Revision Counsel. 26 U.S.C. 1411 – Imposition of Tax For 2026 that threshold is $16,000.4IRS. 2026 Form 1041-ES Estimated Income Tax for Estates and Trusts Net investment income covers interest, dividends, capital gains, rental income, and royalties. Because the threshold is so low, most trusts that hold on to meaningful investment income owe this too, bringing the effective top rate on retained ordinary income to 40.8 percent.
How Distributions Shift the Tax to Beneficiaries
When a non-grantor trust distributes income, it gets a deduction and the beneficiaries pick up the income on their own returns.6Office of the Law Revision Counsel. 26 U.S.C. 661 – Deduction for Estates and Trusts Accumulating Income or Distributing Corpus The maximum amount that can be pushed out to beneficiaries in a given year is capped by distributable net income, or DNI. DNI is essentially the trust’s taxable income with certain adjustments; notably, capital gains allocated to trust principal are excluded unless they are actually distributed.7Office of the Law Revision Counsel. 26 U.S.C. 643 – Definitions Applicable to Subparts A, B, C, and D
Beneficiaries find out what they owe from a Schedule K-1 issued by the trust. The K-1 breaks the income out by type, and each type keeps its character on the beneficiary’s return: interest stays interest, qualified dividends stay qualified dividends, and so on.8Internal Revenue Service. SOI Tax Stats – Definitions of Selected Terms and Concepts for Income From Trusts and Estates A quick example: if a trust earns $10,000 and distributes $8,000, the trust pays tax on the $2,000 it kept and the beneficiaries report the $8,000.
Principal Distributions Aren’t Taxed
Distributions of the trust’s principal, meaning the original assets that funded it, generally aren’t subject to income tax. Those assets were already taxed or otherwise accounted for before they went into the trust. Only income the trust earns is available for a second layer of tax; the underlying body of assets can pass to beneficiaries without one.8Internal Revenue Service. SOI Tax Stats – Definitions of Selected Terms and Concepts for Income From Trusts and Estates
The 65-Day Rule Gives Trustees a Second Chance
A trustee who reaches year-end without distributing enough to shift income out of the trust still has a window. Under the 65-day rule, the trustee can elect to treat a distribution made in the first 65 days of a new tax year as though it were paid on the last day of the prior year.9Office of the Law Revision Counsel. 26 U.S.C. 663 – Special Rules Applicable to Sections 661 and 662 For a calendar-year trust, a distribution paid by March 6, 2026 can count as a 2025 distribution. The election is made on the earlier year’s Form 1041. It lets the trustee see the final numbers before choosing how much to send out and to whom.
Capital Gains Inside a Trust
When a trust sells appreciated stock, real estate, or another asset, the gain is taxed. If the trust keeps the gain, the same compressed structure applies. For 2026, long-term capital gains rates for trusts are:10IRS. Revenue Procedure 25-32 – 2026 Adjusted Items
- 0 percent on gains within taxable income up to $3,300
- 15 percent from $3,300 to $16,250
- 20 percent above $16,250
An individual doesn’t hit the 20 percent capital gains rate until taxable income tops roughly $518,900 (single) or $583,750 (married filing jointly). A trust gets there at $16,250. Add the 3.8 percent net investment income tax and the top rate on long-term gains reaches 23.8 percent. When the trust document allows it, distributing capital gains to beneficiaries in lower brackets can meaningfully cut the total bill.
Step-Up in Basis at the Grantor’s Death
Assets in a revocable trust generally get a step-up in basis to fair market value on the date of the grantor’s death. Appreciation that occurred while the grantor was alive is never taxed as income. If the trust holds stock the grantor bought for $50,000 and it is worth $200,000 at death, the beneficiary’s basis resets to $200,000, and an immediate sale produces no taxable gain. Revocable trust assets qualify because they are treated as owned by the grantor for tax purposes and so count as property acquired from a decedent.
Irrevocable trust assets don’t get an automatic step-up, because the grantor already gave them away. A step-up can still apply if the trust was structured so those assets remain in the grantor’s gross estate for estate tax purposes, but that outcome depends on how the trust was drafted.
Estate Tax Is a Separate Question
Income tax is not the only federal tax on a trust. At the grantor’s death, the IRS asks whether the trust’s assets count toward the federal estate tax. Assets in a revocable trust are pulled into the grantor’s gross estate because the grantor kept the power to take them back.11IRS. Trust Primer For deaths in 2026, the federal estate tax exemption is $15,000,000 per person, and only the value above that is taxed, at rates up to 40 percent.12Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026, Including Amendments From the One, Big, Beautiful Bill
Irrevocable trusts are built to keep assets out of the taxable estate. By permanently giving up ownership and control, the grantor keeps those assets and any future growth from counting against the exemption.11IRS. Trust Primer Retained powers over beneficiaries or personal benefit from the trust can pull the assets back in, so drafting matters.
Filing, Estimated Payments, and Penalties
A calendar-year trust files Form 1041 by April 15 of the following year. A fiscal-year trust files by the 15th day of the fourth month after its tax year ends.13Internal Revenue Service. 2025 Instructions for Form 1041 and Schedules A, B, G, J, and K-1 An automatic five-and-a-half-month extension pushes an April 15 deadline to September 30, but the extension buys only filing time.14eCFR. 26 CFR 1.6081-6 – Automatic Extension of Time to File Estate or Trust Income Tax Return Tax owed is still due by the original date.
A trust that expects to owe at least $1,000 for 2026 after withholding and credits generally has to make quarterly estimated payments. For a calendar-year trust the 2026 due dates are April 15, June 15, and September 15, then January 15, 2027.4IRS. 2026 Form 1041-ES Estimated Income Tax for Estates and Trusts Missing a quarter can trigger an underpayment penalty even if the annual return is on time.
Filing Form 1041 late costs 5 percent of the unpaid tax per month, capped at 25 percent. If the return is more than 60 days late, the minimum penalty is the lesser of $525 or the full tax owed. Paying late adds a separate 0.5 percent per month, also capped at 25 percent, and the two run at the same time.13Internal Revenue Service. 2025 Instructions for Form 1041 and Schedules A, B, G, J, and K-1
Foreign Trusts Have Their Own Reporting
If you create a foreign trust, transfer assets to one, receive a distribution from one, or are treated as the owner of foreign trust assets, you have to file Form 3520.15Internal Revenue Service. Instructions for Form 3520 Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts The penalties are steep. The initial hit is the greater of $10,000 or 35 percent of the gross reportable amount. Once the IRS sends a notice and 90 days pass, another $10,000 accrues for each additional 30 days.16Office of the Law Revision Counsel. 26 U.S.C. 6677 – Failure to File Information With Respect to Certain Foreign Trusts A reasonable-cause waiver is possible, but timing is everything.
State Taxes Are on Top of Federal
Federal is only one layer. Most states tax trust income too, with rates running from around 1 percent to over 13 percent. States use different tests to decide who has the right to tax a given trust: where the grantor lived when the trust was created, where the trustee sits, or where the beneficiaries live. A few states, including those with no individual income tax, don’t tax trust income at all. A trust with ties to more than one state may end up filing in each of them.