How Revocable Trusts Are Taxed When the Grantor Dies

When the grantor of a revocable trust dies, two separate federal taxes come into play: the estate tax, which counts the trust’s assets as part of the grantor’s taxable estate, and income tax, which now applies to the trust as a standalone taxpayer with unusually harsh brackets. Understanding how revocable trusts are taxed when the grantor dies matters because the trust reaches the top 37% federal income tax rate at just $16,000 of taxable income in 2026, while the $15 million estate tax exemption means most estates owe nothing on the estate side. The successor trustee’s decisions in the first year, especially around distributions and elections, largely determine how much of the trust’s value survives to reach the beneficiaries.

Estate Tax on Trust Assets

A revocable trust does not shield assets from the federal estate tax. Because the grantor kept the power to change or revoke the trust until death, federal law pulls every dollar inside it into the taxable estate at fair market value on the date of death.¹²

For decedents dying in 2026, the federal basic exclusion amount is $15,000,000 per person, a level Congress recently made permanent.³ If the combined value of trust assets and other estate property stays below that threshold, no federal estate tax is owed. Estates that exceed it face graduated rates starting at 18% and climbing to 40% on amounts more than $1 million above the exemption.⁴

Avoiding probate and avoiding estate tax are separate things. The trust saves time and legal fees on the distribution side, but the IRS still counts every asset the grantor controlled at death.

When an estate tax return is required, the executor or successor trustee files Form 706 within nine months of the date of death. A six-month extension is available by filing Form 4768 before that deadline.⁵

Portability for a Surviving Spouse

When the first spouse to die does not use their full $15 million exemption, the survivor can inherit the leftover portion through the deceased spousal unused exclusion, or DSUE. A married couple can effectively shelter up to $30 million from estate tax, but only if the executor files a timely, complete Form 706 for the first spouse’s estate, even when the estate owes no tax.⁵

The portability election is made by filing Form 706 within the standard nine-month deadline (plus the six-month extension if requested), and once made it is irrevocable. Executors who were not otherwise required to file may still elect portability by submitting Form 706 on or before the fifth anniversary of death, noting at the top of the return that it is filed pursuant to Rev. Proc. 2022-32.⁵ A surviving spouse who never claims the DSUE amount permanently loses it, potentially exposing millions to the 40% top rate when the survivor later dies.

Step-Up in Basis

The main tax benefit of inheriting through a revocable trust is the step-up in basis. Each asset’s cost basis resets to its fair market value on the date the grantor died, not what the grantor originally paid.⁶ If the grantor bought stock decades ago for $10,000 and it was worth $100,000 at death, the beneficiary’s new basis is $100,000. Selling it the next week for $100,000 produces no capital gain. Without this rule, the beneficiary would owe capital gains tax on the entire $90,000 of appreciation that built up during the grantor’s lifetime.

The step-up applies to real estate, brokerage accounts, business interests, and virtually any appreciated asset inside the trust. The successor trustee should lock down valuations right away. Brokerage statements showing closing prices on the date of death usually suffice for publicly traded securities. Real estate, closely held businesses, and collectibles need formal appraisals. If Form 706 is filed, the basis reported on that return controls what the beneficiary can later claim.⁶ Errors here surface years later when the beneficiary sells the property and the IRS disputes the reported gain.

The Trust Becomes a Separate Income Taxpayer

During the grantor’s life, a revocable trust is invisible for income tax purposes. All earnings flow onto the grantor’s personal return under their Social Security number. That arrangement ends at death. From then on, the trust is a standalone taxpayer that must report every dollar of interest, dividends, rental income, and capital gains it earns.⁷

Getting an EIN

The trust can no longer use the grantor’s Social Security number. The successor trustee must obtain a new Employer Identification Number before filing returns or opening new accounts. The IRS online application issues the number immediately.⁸ Form SS-4 is the alternative by mail or fax.⁹ The trustee will need the grantor’s name, Social Security number, date of death, and the trust document.

Compressed Tax Brackets

This is where post-death trust taxation turns punishing. Trusts and estates use a drastically compressed rate schedule compared to individuals. For 2026:¹⁰

10% on taxable income up to $3,300
24% on $3,301 to $11,700
35% on $11,701 to $16,000
37% on everything above $16,000

An individual does not reach 37% until income exceeds several hundred thousand dollars. A trust gets there at $16,000. Any income left inside the trust gets taxed at rates most people associate with very high earners, which is why distributing income to beneficiaries in lower brackets almost always saves money.

Shifting Income to Beneficiaries

The trust does not always bear the full tax on its income. When the trustee distributes income to beneficiaries, the trust claims a deduction for the amount distributed, and the beneficiaries pick up that income on their personal returns. The IRS uses distributable net income (DNI) to cap how much income can shift in a given year. The trustee reports each beneficiary’s share on a Schedule K-1 attached to Form 1041, and each beneficiary uses that K-1 when filing their own return.¹¹

Capital gains are treated differently. They are generally excluded from DNI and stay taxed at the trust level unless the trust document allocates them to income, the trustee consistently treats them as distributions on the trust’s books, or they are actually paid out. In the trust’s final year, when everything is distributed, remaining capital gains do pass through to the beneficiaries.

The 65-Day Rule

Trustees who miss the December 31 window have a second chance. The fiduciary can elect to treat any distribution made within the first 65 days of the new year as if it had been made on the last day of the prior tax year.¹² The amount eligible cannot exceed the trust’s DNI for that prior year. The election is made on Form 1041 for the year the income was earned, and it gives trustees meaningful flexibility to manage the trust’s tax liability after seeing the full year’s numbers.

The Section 645 Election

When the decedent’s estate also goes through probate alongside the revocable trust, the trustee and executor can jointly elect to treat the trust as part of the estate for income tax purposes. Made on Form 8855, this election merges the two entities into a single taxpayer for a limited period.¹³

The advantages include choosing a fiscal year-end rather than the calendar year trusts are normally locked into, skipping estimated tax payments for the first two years after death, and using the estate’s higher $600 personal exemption instead of the trust’s $100 or $300 exemption. The election lasts until two years after death if no estate tax return is required, or six months after the estate tax liability is finally determined if Form 706 was filed.¹³

The election must be made by the due date (including extensions) of the estate’s first income tax return, and it is irrevocable. Both the executor and trustee must sign Form 8855.¹⁴ If no probate estate exists, the election is not available.

Filing Form 1041

The successor trustee reports the trust’s income, deductions, and distributions on Form 1041.¹⁵ A return is required for any tax year in which the trust has any taxable income or gross income of $600 or more. For a calendar-year trust, the deadline is April 15 of the following year. An automatic five-and-a-half-month extension is available by filing Form 7004 before that date.¹¹

Estimated Tax Payments

A trust that expects to owe at least $1,000 in tax for the year, after withholding and credits, generally must make quarterly estimated payments. But a qualified revocable trust (one that was revocable at death and either receives the residue of the estate or is responsible for paying its debts and expenses) is exempt from estimated tax requirements for any tax year ending within two years of the grantor’s death.¹⁶ After that window closes, quarterly payments on Form 1041-ES become necessary to avoid underpayment penalties.

Late Filing and Payment Penalties

Missing the filing deadline triggers a penalty of 5% of the unpaid tax for each month or partial month the return is late, capped at 25%. If the return is more than 60 days late, the minimum penalty is the lesser of $525 or the full amount of tax due. Unpaid tax accrues a separate penalty of 0.5% per month, also capped at 25%.¹⁶ The penalties stack, and interest runs on top of both. Filing an extension avoids the late-filing penalty but does not extend the time to pay, so successor trustees still gathering records should file Form 7004 and pay an estimated amount by April 15 to limit exposure.

State Estate and Inheritance Taxes

Federal rules are only part of the picture. Roughly a dozen states and the District of Columbia impose their own estate tax, and several others levy an inheritance tax on the recipients. State exemption thresholds are often far lower than $15 million. Oregon’s threshold sits at $1 million, Massachusetts starts at $2 million, and several others fall between $3 million and $7 million. A few states, including New York, use a “cliff” structure where exceeding the exemption by more than 5% eliminates the exemption entirely rather than just taxing the excess.

Inheritance tax states such as Pennsylvania, Kentucky, and New Jersey tax the person receiving the assets, and the rate often depends on the beneficiary’s relationship to the decedent. Spouses are typically exempt; distant relatives and unrelated beneficiaries face higher rates. A trust with assets or beneficiaries in multiple states may trigger filing obligations in more than one jurisdiction, so the successor trustee should check the rules for every state where the trust holds property or where beneficiaries live.

1
Office of the Law Revision Counsel. 26 U.S. Code 2038 – Revocable Transfers
2
Office of the Law Revision Counsel. 26 U.S.C. 2031 – Definition of Gross Estate
3
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
4
Internal Revenue Service. What’s New – Estate and Gift Tax
5
Internal Revenue Service. Instructions for Form 706
6
Office of the Law Revision Counsel. 26 U.S.C. 1014 – Basis of Property Acquired From a Decedent
7
Office of the Law Revision Counsel. 26 U.S.C. 641 – Imposition of Tax
8
Internal Revenue Service. Get an Employer Identification Number
9
Internal Revenue Service. About Form SS-4, Application for Employer Identification Number (EIN)
10
Internal Revenue Service. Rev. Proc. 2025-32
11
Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1
12
eCFR. 26 CFR 1.663(b)-1 – Distributions in First 65 Days of Taxable Year
13
Office of the Law Revision Counsel. 26 U.S. Code 645 – Certain Revocable Trusts Treated as Part of Estate
14
Internal Revenue Service. Form 8855 – Election to Treat a Qualified Revocable Trust as Part of an Estate
15
Internal Revenue Service. About Form 1041, U.S. Income Tax Return for Estates and Trusts
16
Internal Revenue Service. 2025 Instructions for Form 1041 and Schedules A, B, G, J, and K-1