Is a Trust Taxed? Brackets, the 65-Day Rule, and K-1s

How a trust is taxed depends almost entirely on how the Internal Revenue Code classifies it. A grantor trust is invisible to the IRS, and the person who created it reports all the income on their own Form 1040. A non-grantor trust is a separate taxpayer that files its own return, pays tax on income it keeps, and passes the tax bill to beneficiaries on income it distributes. The pressure point in 2026: a non-grantor trust hits the top federal rate of 37% at just $16,000 of taxable income, which gives trustees a real reason to distribute rather than accumulate.

Grantor Trust or Non-Grantor Trust

Every trust falls into one of two tax categories, and the label controls who writes the check.¹

A grantor trust exists when the person who created the trust keeps enough control over its assets or income that the IRS treats the trust as if it doesn’t exist for tax purposes. All income, deductions, and credits flow to the grantor’s personal return. The trust itself owes nothing and generally doesn’t file a Form 1041. The trustee just hands the grantor a statement of the trust’s income, deductions, and credits so the grantor can report them.²

A non-grantor trust is its own taxpayer. It files Form 1041, reports income, and either pays tax on what it keeps or deducts what it distributes and passes the tax to the beneficiaries. Income is never taxed twice.³

Revocable and irrevocable trusts map loosely onto these categories but not automatically. A revocable trust is almost always a grantor trust because the grantor can undo it. An irrevocable trust is usually a non-grantor trust, but if the grantor keeps certain powers spelled out in the code, an irrevocable trust can still be taxed as a grantor trust.⁴

What Triggers Grantor Trust Status

Several retained powers flip a trust into grantor status. The power to revoke makes the whole trust the grantor’s for tax purposes.⁵ A reversionary interest worth more than 5% of the trust’s value at the time of transfer does the same.⁶ So can retaining control over who benefits from the income or principal, or the ability to borrow from the trust without adequate security.

Partial grantor trust status is possible. If only part of the trust is subject to these powers, only that portion is taxed to the grantor, and the rest is taxed under the non-grantor rules.³

How Non-Grantor Trusts Pay Tax

The code splits non-grantor trusts into two subtypes, and the distinction affects how much of the tax the trust pays versus how much flows to beneficiaries.

A simple trust must distribute all of its income every year, cannot distribute principal, and cannot make charitable contributions. Because all the income goes out, the beneficiaries pay all the tax on it. The trust still files a return but typically owes nothing on ordinary income.⁷

A complex trust is any non-grantor trust that isn’t simple. It can accumulate income, distribute principal, or give to charity. The trust pays tax on income it keeps; beneficiaries pay tax on income they receive. Because trust rates are so steep, pushing income out to beneficiaries in lower brackets is one of the main planning levers a trustee has.

Distributable Net Income Sets the Ceiling

Distributable net income, or DNI, caps two things at once: the trust’s deduction for distributions and the amount of income beneficiaries have to report. DNI starts with the trust’s taxable income and adjusts from there, most notably by excluding capital gains that stay in the trust and including tax-exempt interest.⁸

Distribute more than DNI and the excess isn’t taxable to the beneficiaries as income. The trust’s distribution deduction is also capped at DNI, so a trustee can’t zero out the tax bill by distributing principal.⁹

Distributed income keeps its character on the way out. Qualified dividends stay qualified dividends, tax-exempt interest stays tax-exempt, and beneficiaries apply the same preferential rates they would if they’d earned the income directly.

2026 Trust Tax Brackets

Trust brackets are compressed, and that’s the whole reason trust taxation gets so much attention. A single individual doesn’t reach 37% federal until taxable income passes roughly $626,000. A trust gets there at $16,000. The 2026 ordinary-income schedule for non-grantor trusts:

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

Trusts skip the 12% and 22% brackets entirely. On $20,000 of ordinary income, a trust pays a higher effective rate than most individuals would on the same amount.

Capital Gains Inside the Trust

Long-term capital gains face similarly compressed thresholds in 2026: 0% up to $3,300, 15% from $3,301 to $16,250, and 20% above $16,250. Capital gains are generally allocated to principal rather than treated as distributable income, so they usually stay in the trust and get taxed at the trust level. The governing instrument or state law can override that default.

Net Investment Income Tax

On top of the regular rates, a non-grantor trust may owe the 3.8% Net Investment Income Tax on undistributed investment income. NIIT applies to the lesser of the trust’s net investment income or the amount by which its adjusted gross income exceeds the top-bracket threshold, which is $16,000 for 2026.¹⁰ A trust that keeps $20,000 of investment income can face a combined 40.8% on the amount above the threshold. Distributing the income shifts the NIIT question to the beneficiaries, who only owe it if their own income exceeds the individual threshold ($200,000 single, $250,000 married filing jointly).¹¹

The 65-Day Rule

Trustees of complex trusts have one of the most useful planning levers in the code: the 65-day election. A distribution made in the first 65 days of a new tax year can be treated as if it were paid on the last day of the prior year. The trustee gets to see how the trust’s income actually landed before deciding how much to push out for that year’s tax purposes.¹²

The backdated amount is capped at the prior year’s DNI. The election has to be made affirmatively on the prior-year return every year; it’s not automatic. Trustees who don’t know about it end up paying trust-level rates on income that could have gone out to beneficiaries in lower brackets.

What Changes When the Grantor Dies

The grantor’s death is the most significant tax event in a trust’s life. A revocable trust stops being a grantor trust the moment the grantor can no longer revoke it. From that point forward it’s a non-grantor trust, needs its own Employer Identification Number, and starts filing Form 1041.¹³

Assets held in a revocable trust at death generally get a step-up in basis to fair market value, same as assets passing through a will. Decades of unrealized gain can disappear in a single moment.¹⁴

Irrevocable grantor trusts are different. Under IRS Revenue Ruling 2023-2, assets transferred to an irrevocable grantor trust that aren’t included in the grantor’s taxable estate do not receive a step-up at death. If the grantor used the trust for estate tax savings or creditor protection, the beneficiaries inherit the original cost basis and may owe capital gains on the full appreciation when they sell.

When a grantor dies leaving both an estate and a revocable trust, the executor and trustee can elect under section 645 to treat the trust as part of the estate for tax purposes, which avoids filing two sets of returns during administration.¹⁵

Filing, K-1s, and Deadlines

A non-grantor trust must file Form 1041 if it has $600 or more of gross income, or any taxable income at all, during the year.³ For a calendar-year trust, the return is due April 15.¹⁶ Trustees can request an automatic five-and-a-half-month extension with Form 7004, pushing the filing deadline to the end of September.¹⁷ The extension buys time to file, not time to pay. Tax owed is still expected by April 15.

When a trust makes distributions, the trustee issues a Schedule K-1 to each beneficiary showing the character of what they received (ordinary income, qualified dividends, capital gains, tax-exempt interest). Beneficiaries are legally required to report K-1 amounts on their own Form 1040.³

Trusts don’t have withholding. If a non-grantor trust expects to owe $1,000 or more for the year, it must make quarterly estimated payments on Form 1041-ES.¹⁸ Calendar-year trusts follow the usual individual estimated-payment schedule: April 15, June 15, September 15, and January 15 of the following year.

Penalties

Missing a Form 1041 deadline is expensive. The late-filing penalty is 5% of unpaid tax per month, capped at 25%. If the return is more than 60 days late, the minimum penalty is the smaller of $525 or the total tax due. A separate late-payment penalty runs at 0.5% per month, also capped at 25%. The two stack, and interest accrues on top of both. Reasonable cause can get the penalties waived.³

State Taxes and Foreign Trusts

Federal rules are only part of the picture. Most states with an income tax also tax trust income, but the rules for when a particular state can tax a trust vary widely. Some look to where the grantor lived, others to where the trustee is located, others to where the trust was created or where its assets sit. A few states don’t tax trust income at all. Trustees whose trusts touch more than one state should expect overlapping filing requirements.

Foreign trusts are their own universe. A U.S. person who creates, funds, is treated as owning, or receives a distribution from a foreign trust generally has to file Form 3520, and the penalties for missing the filing run into the tens of thousands of dollars or a percentage of the amounts involved.¹⁹ Anyone with a foreign trust connection should get specialized advice before the next filing deadline.

1
Internal Revenue Service. Defining the Entity – Foreign Trusts
2
Internal Revenue Service. Abusive Trust Tax Evasion Schemes – Facts (Section II)
3
Internal Revenue Service. 2025 Instructions for Form 1041 and Schedules A, B, G, J, and K-1
4
Internal Revenue Service. Abusive Trust Tax Evasion Schemes – Questions and Answers
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Office of the Law Revision Counsel. 26 USC 676 – Power to Revoke
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Office of the Law Revision Counsel. 26 USC 673 – Reversionary Interests
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IRS. Taxation of Beneficiary of a Foreign Non-Grantor Trust
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Office of the Law Revision Counsel. 26 USC 643 – Definitions Applicable to Subparts A, B, C, and D
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Office of the Law Revision Counsel. 26 USC 651 – Deduction for Trusts Distributing Current Income Only
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Internal Revenue Service. Topic No. 559, Net Investment Income Tax
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Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
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Office of the Law Revision Counsel. 26 USC 663 – Special Rules Applicable to Sections 661 and 662
13
Internal Revenue Service. When to Get a New EIN
14
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
15
Office of the Law Revision Counsel. 26 USC 645 – Certain Revocable Trusts Treated as Part of Estate
16
Internal Revenue Service. Forms 1041 and 1041-A: When to File
17
Internal Revenue Service. Instructions for Form 7004
18
Internal Revenue Service. 2025 Form 1041-ES
19
Internal Revenue Service. Instructions for Form 3520