A trust makes money the same ways any investor does: it collects interest on cash and bonds, dividends on stocks, rent on real estate, royalties on intellectual property, profits from businesses it owns, and capital gains when assets it holds are sold for more than their basis. What sets a trust apart is not how the income comes in but what happens next. A non-grantor trust reaches the top 37% federal bracket at just $16,000 of taxable income in 2026, so the trustee’s choices about distributing, retaining, and investing earnings shape the real return far more than they would for an individual.1Internal Revenue Service. 2026 Form 1041-ES
The Assets That Produce the Income
Before a trust earns a dollar, the grantor has to fund it. Property gets transferred into the trust’s name, and that starting pool is called the principal or corpus. Typical holdings include real estate transferred by deed, brokerage accounts retitled to the trustee, cash deposited into accounts under the trust’s own tax identification number, and ownership interests in private businesses or LLCs. An irrevocable trust is treated as a separate tax entity and needs its own Employer Identification Number from the IRS to open accounts and file returns.2Internal Revenue Service. Get an Employer Identification Number
The mix determines the income. A trust funded entirely with Treasury bonds earns interest. One holding apartment buildings collects rent. Most well-funded trusts hold a combination, and the trustee manages that mix to serve the beneficiaries over time.
Interest, Dividends, and Royalties
The simplest earnings come from financial instruments that pay on a schedule. Cash in interest-bearing accounts and certificates of deposit produces interest. Corporate and municipal bonds pay periodic interest as well. These payments flow into the trust’s accounts without the trustee having to sell anything.
Publicly traded stocks often pay dividends, usually quarterly. When the trust is the shareholder, that money belongs to the trust. Qualified dividends receive preferential rates compared with ordinary income, which matters enormously given how quickly trust brackets climb.
Trusts can also hold intellectual property such as copyrights, patents, and trademarks. A trust that owns a book catalog, a music portfolio, or a patented invention collects royalties whenever the property is licensed or used. Royalty income is taxed as ordinary income on the trust’s return, so it hits the compressed brackets fast. Even so, intellectual property can be a durable income source that outlasts the grantor by decades.
Rent and Business Profits
When a trust holds title to real estate, the trustee manages leases and collects rent. After property taxes, insurance, maintenance, and management fees, the net belongs to the trust. Those funds are recorded as trust accounting income and can be distributed or retained.
Rental property carries a real advantage: depreciation. A trust can deduct the cost of residential rental buildings over 27.5 years under the Modified Accelerated Cost Recovery System, even if the property is gaining market value.3Internal Revenue Service. Publication 527, Residential Rental Property Depreciation lowers taxable income on paper without any cash outlay, which matters when every dollar above $16,000 gets taxed at 37%. The trade-off is a lower cost basis, meaning a larger taxable gain when the trustee eventually sells.
Trusts also frequently own stakes in LLCs, partnerships, or S corporations. These entities pass their profits through to the owners, and the trustee receives the trust’s share along with a Schedule K-1 showing how much to include on the trust’s return.4Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1 Business income comes from active operations rather than financial markets, so it can be lumpy and unpredictable.
Capital Gains on Appreciated Assets
A trust also builds wealth when its holdings appreciate. If the trust bought land for $200,000 and the trustee later sells it for $350,000, the $150,000 difference is a capital gain. The gain stays unrealized and untaxed until the sale actually happens, and the tax owed depends on the difference between the sale price and the trust’s adjusted basis in the asset.5Internal Revenue Service. Publication 551, Basis of Assets
Holding period governs the rate. Short-term gains on assets held a year or less are taxed at ordinary income rates, so the compressed brackets apply in full. Long-term gains on assets held longer than a year qualify for preferential rates in 2026: 0% on the first $3,300 of gain, 15% between $3,300 and $16,250, and 20% above that. The brackets are still tight, but the lower rates make a meaningful difference.
Trustees also need to watch the wash sale rule when reinvesting after a loss. Buying the same or a substantially identical security within 30 days before or after the sale disallows the loss and rolls it into the basis of the replacement shares.
Who Pays the Tax: Grantor vs. Non-Grantor Trusts
Not every trust is its own taxpayer, and this distinction is the single biggest factor in what a trust keeps.
A grantor trust is one where the person who created it retains enough control or benefit that the IRS treats the trust’s income as the grantor’s own. Revocable living trusts are grantor trusts by default. Under IRC Section 671, all income, deductions, and credits from a grantor trust flow onto the grantor’s personal return.6Office of the Law Revision Counsel. 26 USC 671 – Trust Income, Deductions, and Credits Attributable to Grantors and Others as Substantial Owners The trust files informationally but pays no tax, and the earnings get taxed at individual rates with much wider brackets.
A non-grantor trust is a separate taxpayer. Most irrevocable trusts fall into this category once the grantor gives up control. The trust files its own Form 1041 and faces the compressed rate schedule below. Every dollar the trust earns and keeps is subject to those steep rates, which is why distribution planning becomes the central lever.
How Trust Income Is Taxed
The 2026 non-grantor trust brackets are:1Internal Revenue Service. 2026 Form 1041-ES
- 10% on taxable income up to $3,300
- 24% on income from $3,300 to $11,700
- 35% on income from $11,700 to $16,000
- 37% on income above $16,000
An individual taxpayer doesn’t hit the 37% bracket until taxable income exceeds roughly $626,000. A trust gets there at $16,000. That gap is the reason trust tax planning revolves around moving income out of the trust and into the hands of beneficiaries, who usually sit in lower brackets.
The main tool is the income distribution deduction. When a trust distributes income to beneficiaries, it deducts those distributions from its own taxable income, and the beneficiaries report the income on their personal returns instead.7Office of the Law Revision Counsel. 26 USC 661 – Deduction for Estates and Trusts Accumulating Income or Distributing Corpus The deduction is capped at the trust’s distributable net income for the year, so a trust cannot deduct more than it actually earned. The income keeps its character on the way through, so qualified dividends and long-term gains hold their preferential rates on the beneficiary’s return.
Two related rules matter. A complex trust can elect to treat distributions made within 65 days after year-end as if they were made on the last day of the prior year, giving the trustee time to review final numbers and push income out to beneficiaries retroactively. And a 3.8% net investment income surtax applies at the trust level to the lesser of undistributed net investment income or the amount by which the trust’s adjusted gross income exceeds the top-bracket threshold of $16,000.8Internal Revenue Service. Topic No. 559, Net Investment Income Tax Retaining more than $16,000 of investment income can put the marginal rate at 40.8%.
Income vs. Principal: What the Trustee Can Actually Distribute
Trust law separates income from principal in a way that does not match the IRS definition of taxable income. Under most state trust codes, interest, dividends, and net rental receipts are income. Capital gains, stock splits, and proceeds from selling trust assets are principal. That distinction matters because many trust documents tell the trustee to distribute “all income” to one beneficiary while preserving principal for someone else down the line.
A trustee working under a trust that says “distribute all income to my spouse for life, then distribute principal to my children” has to know which dollars are which. If the trust sells stock at a gain, that profit typically adds to principal rather than becoming distributable income, even though it is clearly taxable. Some items count as taxable income under the tax code but as principal under state law, and vice versa.
The fiduciary must figure trust accounting income under applicable state law and the governing document before calculating the income distribution deduction on the federal return.4Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1 Getting this wrong means distributing too much, too little, or misreporting on Schedule K-1.
How the Trustee Is Allowed to Invest
The trustee does not have a free hand. Nearly every state has adopted some version of the Uniform Prudent Investor Act, which sets legal guardrails around trust investments. The trustee owes a fiduciary duty to act in the beneficiaries’ best interests, and the Act defines what that looks like in practice.9Cornell Law Institute. Fiduciary Duties of Trustees
Investment decisions are judged on the overall portfolio, not any single asset. A trustee can hold a speculative stock if the rest of the portfolio balances the risk. The Act requires trustees to diversify, consider the beneficiaries’ needs and circumstances, weigh tax consequences, and balance current income against long-term growth. Putting everything into one stock or letting cash sit in a non-interest-bearing account can expose the trustee to personal liability.
This is why most professionally managed trusts hold a diversified mix. A trust for a 90-year-old beneficiary who needs monthly income looks very different from one holding assets for grandchildren who will not receive anything for 30 years.
What Comes Off the Top Before Anyone Gets Paid
Trusts carry operating costs that individual investors do not face, and these expenses cut directly into what the beneficiaries eventually receive.
Tax preparation is a guaranteed annual expense. The IRS estimates that preparing a Form 1041 for a simple trust averages around $1,300, and about $2,000 for a complex trust.4Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1 Trusts with rental properties, business interests, or multi-state filings can run higher. A revocable grantor trust avoids this cost, since its income goes on the grantor’s own return.
Trustee compensation is the other major line item. Professional trustees, whether banks, trust companies, or attorneys, typically charge an annual fee calculated as a percentage of assets under management. Fees in the range of 0.5% to 1.5% of trust assets per year are common. On a $2 million trust, that is $10,000 to $30,000 per year before any investment returns. Individual trustees serving without compensation avoid the fee but take on real personal liability for investment decisions and administration.
Beyond these, trusts may also pay legal fees for document amendments, court filing fees for required accountings, separate investment management fees, and insurance premiums. A trust generating 5% annual returns but paying 2% in combined fees is only netting 3% for its beneficiaries, and that drag is what ultimately decides whether the structure earns its keep.