Yes, trusts are taxed at a higher rate than individuals, and the gap is severe. In 2026 a non-grantor trust reaches the top 37% federal bracket at just $16,000 of retained taxable income, while a single filer doesn’t hit that same rate until $640,600.1Internal Revenue Service. Rev. Proc. 2025-322Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 The penalty only bites on income the trust keeps, though. Distribute the earnings to beneficiaries or use a grantor structure and most of the difference disappears.
How the Brackets Actually Compare
For 2026, trusts and estates use only four brackets, and they compress into a total range of $16,000:1Internal Revenue Service. Rev. Proc. 2025-32
- 10% on taxable income up to $3,300
- 24% from $3,301 to $11,700
- 35% from $11,701 to $16,000
- 37% on everything above $16,000
Individual filers get the same rate ladder spread across vastly more income. A single filer stays in the 10% bracket through the first $12,400 and doesn’t reach 37% until $640,600. Married couples filing jointly cross into the top bracket only after $768,700.2Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
Run the numbers on a real amount. A trust with $50,000 of retained income pays the top rate on most of it. A single filer earning $50,000 is still in the 22% bracket.
Deductions widen the gap further. A single filer can shield $16,100 of income behind the standard deduction in 2026, and married couples get $32,200.2Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Trusts get no standard deduction. A simple trust (one required to distribute all its income each year) receives a flat $300 exemption. A complex trust gets $100.3Office of the Law Revision Counsel. 26 USC 642 – Special Rules for Credits and Deductions So a trust starts paying tax on essentially its first dollar of income, while an individual with the same earnings might owe nothing at all.
The Compressed Rates Only Apply to Some Trusts
Whether the punishing rates actually matter depends on the type of trust.
Grantor Trusts Pay No Trust-Level Tax
A grantor trust is invisible to the IRS as a separate taxpayer. When the person who creates and funds the trust keeps certain powers over the assets, such as the ability to revoke the trust, control beneficial enjoyment, or substitute assets, the tax code attributes all income to that person.4Office of the Law Revision Counsel. 26 USC 671 – Trust Income, Deductions, and Credits Attributable to Grantors and Others as Substantial Owners Revocable living trusts, the most common estate planning vehicle for avoiding probate, are almost always grantor trusts.
Income from a grantor trust flows straight onto the grantor’s personal Form 1040 and is taxed at whatever individual rate applies. The trust doesn’t file its own return. The compressed brackets never enter the picture. A grantor trust with $100,000 of investment income is taxed exactly the same as if the grantor had earned that money directly.
Non-Grantor Trusts Are Where the Rates Bite
Once the grantor gives up enough control, the trust becomes a separate taxpayer under the federal code.5Office of the Law Revision Counsel. 26 USC 641 – Imposition of Tax The trustee obtains a Taxpayer Identification Number and files Form 1041 each year. Anything the trust retains at year-end is taxed on the compressed schedule. Income above $16,000 is taxed at 37%.
Distributing Income Is the Primary Way to Avoid the Penalty
The most effective response to compressed trust brackets is to distribute income to beneficiaries. When a non-grantor trust pays out income, it claims a distribution deduction that reduces its own taxable income by the amount distributed.6Office of the Law Revision Counsel. 26 USC 661 – Deduction for Estates and Trusts Accumulating Income or Distributing Corpus A trust distributing all of its income can drop its taxable income to essentially zero, shifting the tax burden to the beneficiaries.
The deduction is capped at a figure called distributable net income (DNI), which represents the maximum amount the trust can shift to beneficiaries for tax purposes.7Office of the Law Revision Counsel. 26 USC 651 – Deduction for Trusts Distributing Current Income Only Beneficiaries receive a Schedule K-1 reporting their share and report the income on their personal returns.
The math is straightforward. A $50,000 distribution to a beneficiary in the 22% bracket saves roughly $7,500 in tax compared to leaving that income inside a trust facing the 37% rate.
The 65-Day Rule Buys Time
Trustees rarely know the trust’s exact income until after the year ends. The 65-day rule lets a trustee make a distribution during the first 65 days of a new tax year and elect to treat it as though paid on the last day of the prior year.8GovInfo. 26 CFR 1.663(b)-1 – Distributions in First 65 Days of Taxable Year For a calendar-year trust, distributions made by March 6 can count against the prior year.
The election is made on Form 1041 at filing and becomes irrevocable once the filing deadline passes. It gives the trustee a window to review actual year-end figures and distribute just enough to keep the trust out of the top brackets retroactively.
Capital Gains Are Compressed the Same Way
Long-term capital gains inside a trust use the same 0%, 15%, and 20% structure that applies to individuals, but the thresholds mirror the compressed income brackets. For 2026:1Internal Revenue Service. Rev. Proc. 2025-32
- 0% on taxable income up to $3,300
- 15% from $3,301 to $16,250
- 20% on everything above $16,250
A single filer can have tens of thousands of dollars in long-term gains taxed at 0%. A trust hits the 20% rate at roughly the same income level where a single individual is still paying nothing. This turns routine portfolio rebalancing or a property sale inside a trust into an expensive event. Where the trust document allows it, distributing appreciated assets to beneficiaries before a sale, so the gain lands on their return at their thresholds, is a common workaround.
Two Extra Taxes That Widen the Gap
The Net Investment Income Tax
On top of ordinary and capital gains rates, trusts owe an additional 3.8% net investment income tax on undistributed investment income. The tax applies to the lesser of the trust’s undistributed net investment income or the amount by which its adjusted gross income exceeds the threshold where the top ordinary bracket begins.9Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax For 2026, that threshold is $16,000, the same point where the 37% bracket kicks in.
Individual filers don’t face the NIIT until income exceeds $200,000 (single) or $250,000 (married filing jointly). A trust earning $20,000 of investment income already owes the surtax on part of it. A single filer would need roughly $180,000 more income before the same tax applied. Combined with the 37% ordinary rate or the 20% capital gains rate, the NIIT can push the effective federal rate on retained trust investment income above 40%.
Investment income covered by the NIIT includes interest, dividends, capital gains, rental income, and royalties. It doesn’t include retirement account distributions or income subject to self-employment tax.9Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax Distributing that income to beneficiaries removes it from the trust’s undistributed pool.
Alternative Minimum Tax
Trusts also face the alternative minimum tax, a parallel calculation that limits the value of certain deductions. For 2026 the trust AMT exemption is $31,400, and it phases out at higher income levels.1Internal Revenue Service. Rev. Proc. 2025-32 Trusts that distribute most of their income rarely trigger AMT, because distributions reduce taxable income for both regular and AMT purposes. The trusts most exposed are those with large retained income and deductions that AMT disallows, such as state and local taxes.
Why the Rates Are Structured This Way
Congress compressed the trust brackets to shut down income-shifting. Without them, a wealthy taxpayer could split earnings across multiple trusts, each claiming the lower individual brackets. Taxing retained trust income at the top rate almost immediately removes the incentive.
The practical result: trusts pay more than individuals, but only on income they keep. A non-grantor trust that pushes income out to beneficiaries in lower brackets can neutralize most of the penalty. A grantor trust avoids it entirely because the income is taxed on the grantor’s personal return. For families using trusts, the annual distribution decision drives more of the tax outcome than almost anything else. Trustees who wait until tax season to think about it have already given up their best leverage, though the 65-day rule may still salvage part of the year.