A marital trust must pay all of its net income to the surviving spouse at least once a year, and the spouse reports those income distributions on their own Form 1040 at individual tax rates rather than at the trust’s compressed brackets. That mandatory payout is a condition of the federal estate tax marital deduction, so the rule is not something the trustee or the trust document can soften.
The Annual Payout Rule
For a trust to qualify for the marital deduction, the surviving spouse must be entitled to all of the trust’s net income for life, distributed at least annually.1eCFR. 26 CFR 20.2056(b)-5 Marital Deduction; Life Estate With Power of Appointment in Surviving Spouse Most trust documents call for quarterly or monthly payments, which more than satisfies the statutory minimum.2Internal Revenue Service. Private Letter Ruling 202229028 If the trust instrument allows the trustee to accumulate income instead of paying it out, the trust fails to qualify for the marital deduction entirely.
The surviving spouse also has the right to compel the trustee to convert non-income-producing assets into assets that generate income. Raw land, closely held stock that pays no dividends, or growth-oriented investments that throw off little cash can all be challenged. The power exists so a trustee cannot effectively starve the spouse of income while the trust’s value builds for the remainder beneficiaries.
What Happens if the Trustee Skips a Payment
A trustee who accumulates income instead of distributing it risks destroying the trust’s tax status. The IRS can reclassify the interest passing to the surviving spouse as a nondeductible interest, meaning the estate loses the marital deduction for the affected property.1eCFR. 26 CFR 20.2056(b)-5 Marital Deduction; Life Estate With Power of Appointment in Surviving Spouse For a large estate, the lost deduction can translate into millions of dollars in estate tax that would otherwise have been deferred.
The spouse has personal remedies too. A beneficiary who is not receiving mandatory income can petition a court to compel payment, seek removal of the trustee, or sue for breach of fiduciary duty. State trust codes generally allow recovery of the income that should have been distributed plus interest, and trustees can be personally liable for the shortfall.
What Counts as Income to Be Distributed
The amount the trustee must pay out is Trust Accounting Income, or TAI. TAI is not the same as the trust’s taxable income. It is determined by the trust document and by state law, with most states following some version of the Uniform Principal and Income Act or its successor, the Uniform Fiduciary Income and Principal Act.
The core distinction: receipts that represent earnings on the trust’s assets are income, while receipts that represent a change in the form of an asset are principal.
- Income includes interest, cash dividends, rental payments, and royalties.
- Principal includes capital gains from selling securities or real estate, stock splits, insurance proceeds, and the original assets the grantor contributed.
A trust loaded with growth stocks and few dividend payers can technically generate very little TAI even as it appreciates substantially. The surviving spouse gets distributions based on income, not on total return, unless the trust document or state law provides otherwise.
Expenses That Reduce the Check
Before the trustee cuts the income payment, allowable expenses reduce gross TAI to net TAI. The trust document and state law determine which expenses come from income, which come from principal, and which are split. Trustee compensation, investment advisory fees, and property management costs are commonly divided. Legal and accounting fees for the trust’s tax return are often charged to income, while one-time costs like litigation over the trust’s validity typically come from principal. Corporate trustee fees generally run between 0.5% and 2% of trust assets annually and directly reduce distributable income.
The Unitrust Alternative
Some states let a trustee convert the income interest into a unitrust amount, redefining “income” as a fixed percentage of the trust’s total value each year. Federal regulations treat a state statute that defines income as a unitrust amount between 3% and 5% of fair market value as a reasonable apportionment between income and remainder beneficiaries.3GovInfo. 26 CFR 1.643(b)-1 Definition of Income A trust converted under a qualifying state statute keeps its marital deduction intact.4Internal Revenue Service. Letter Ruling on Proposed Division and Conversion of Marital Trust Not every state has adopted unitrust legislation, and the conversion usually requires court approval or the consent of all interested parties. A unitrust amount outside the 3%-to-5% safe harbor can jeopardize the marital deduction, so the trustee should get a tax opinion before converting.
How the Spouse Is Taxed on the Distributions
Income paid out to the surviving spouse is taxed on the spouse’s individual return, not at the trust level. The mechanism is Distributable Net Income, or DNI, which caps how much of the trust’s distributions are taxable to the beneficiary. The trust claims a deduction for the income it distributes, so the same dollar is not taxed twice.5Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1 (2025)
This pass-through treatment almost always saves money because trust tax brackets are compressed. For the 2025 tax year, trusts and estates hit the top 37% federal rate at just $16,001 of taxable income. An individual filer does not reach that same rate until well over $600,000. Shifting income to the spouse’s return moves it into a bracket structure with far more room at lower rates.
Character Is Preserved
The income does not turn into generic “trust income” when it reaches the spouse. Dividends stay dividends. Tax-exempt interest stays tax-exempt. Capital gains allocated to income under a unitrust or power-of-adjustment provision retain their capital gain character. The trust reports each category on Schedule K-1 (Form 1041), and the spouse transfers those figures to Form 1040.6Internal Revenue Service. About Form 1041, U.S. Income Tax Return for Estates and Trusts Qualified dividends and long-term capital gains passed through keep their favorable rates.
Net Investment Income Tax
Trusts and estates face the 3.8% net investment income tax on the lesser of their undistributed net investment income or adjusted gross income above a threshold that mirrors the top income tax bracket. For 2025, that trust threshold is roughly $16,000. A marital trust that distributes all its income effectively zeroes out its own exposure to the surtax and shifts the NIIT calculation to the spouse’s return, where the threshold is $200,000 for single filers or $250,000 for a married couple filing jointly.5Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1 (2025)
Distributions Above DNI
If the trust distributes more than its DNI in a given year, the excess is treated as a tax-free return of principal. This can happen when a trustee makes a discretionary principal distribution for the spouse’s health, education, maintenance, or support on top of the mandatory income payout. The spouse does not owe income tax on the principal portion.
What the Marital Deduction Does Not Do
The marital deduction defers estate tax; it does not eliminate it. When the surviving spouse dies, the full value of the trust assets is pulled back into their gross estate under IRC Section 2044, even though the spouse never controlled the principal.7Office of the Law Revision Counsel. 26 USC 2044 Certain Property for Which Marital Deduction Was Previously Allowed The IRS presumes Section 2044 applies to the entire trust value unless the executor can prove that no marital deduction was ever claimed.8eCFR. 26 CFR 20.2044-1 Certain Property for Which Marital Deduction Was Previously Allowed
For 2026, the basic estate tax exclusion amount is $15,000,000 per person.9Internal Revenue Service. What’s New — Estate and Gift Tax A surviving spouse whose own assets plus the trust’s value fall below that threshold owes no federal estate tax. For larger estates, the inclusion can push the total above the exclusion, triggering tax of up to 40% on the excess. Because the assets are treated as passing from the surviving spouse, the estate tax is calculated on the trust’s value at the surviving spouse’s date of death, not at the date the trust was funded.