Trust Tax Rates on Capital Gains: Brackets, NIIT, and DNI

Capital gains kept inside a non-grantor trust are taxed at the trust’s own compressed brackets, and that is expensive. Trust tax rates on capital gains reach 20% on long-term gains and 37% on short-term gains once taxable income passes $16,000, and the 3.8% Net Investment Income Tax pushes the combined federal ceiling to 23.8% on long-term gains and 40.8% on short-term gains. For comparison, a single individual doesn’t hit the 37% ordinary rate until income exceeds $640,600, and doesn’t owe the NIIT until modified AGI passes $200,000. The single most effective move to reduce the bill is distributing the gain to a beneficiary, when the trust document allows it, so the gain is taxed on the beneficiary’s return instead.

Long-Term Gains: The 0%, 15%, and 20% Tiers Inside a Trust

Long-term capital gains, on assets held longer than one year, get the same preferential 0%, 15%, and 20% federal rates inside a trust that they get on an individual return. The problem is the income thresholds. For 2025, the 0% rate applied only to the first $3,250 of trust taxable income, and the 20% rate kicked in above $15,900.¹ The 2026 thresholds move up slightly with inflation, but the shape is the same.

The practical result is that the 0% rate is nearly unreachable for a trust. A single stock sale usually pushes the trust past every lower tier and into the 20% bracket. An individual, by contrast, can realize up to $49,450 in long-term gains at the 0% rate in 2026.² Most trusts pay the top 20% federal capital gains rate on any meaningful retained long-term gain.

Short-Term Gains Are Taxed as Ordinary Income

Gains on assets held one year or less are short-term and run through the trust’s ordinary income brackets, which are steeply compressed.³ For 2026:⁴

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

There is no 12%, 22%, or 32% bracket. Income jumps from 10% straight to 24%, and the 37% rate starts at $16,000. A trust with a $20,000 short-term gain and no other income pays 37% on roughly a quarter of it.

The gap between the two holding periods is severe: a 20% long-term rate versus a 37% short-term rate is a 17-point swing on the same dollar of profit. Treating the one-year mark as a hard line, rather than a rough target, is worth real money.

The 3.8% Net Investment Income Tax

Every rate above stacks with the Net Investment Income Tax. The NIIT is a 3.8% surtax on the lesser of the trust’s undistributed net investment income or the excess of the trust’s AGI over the threshold where the top ordinary bracket begins.⁵ For 2026 that threshold is $16,000, the same $16,000 where the 37% ordinary bracket starts.⁴ There is no planning window between the two.

Net investment income includes capital gains, interest, dividends, rents, and passive business income. Combined with the regular rates, the maximum federal hit is 23.8% on retained long-term gains and 40.8% on short-term gains and other ordinary investment income. Individuals don’t owe the NIIT until modified AGI exceeds $200,000 single or $250,000 joint.⁶ The trustee reports the NIIT on Form 8960, filed with Form 1041.⁷

Grantor Trusts Are a Different Animal

None of the above applies if the trust is a grantor trust. When the person who created the trust kept enough control that the IRS treats it as invisible for income tax purposes, all income and capital gains flow through to the grantor’s personal Form 1040 and are taxed at individual rates.¹ The trust files no tax of its own. The rates and problems described here are the non-grantor trust world, where the trust is a separate taxpayer filing Form 1041.⁸

Pushing Gains Out to Beneficiaries Through DNI

The main lever for cutting a non-grantor trust’s tax bill is the distribution deduction. When the trust distributes income to a beneficiary, it deducts the amount on Form 1041, and the beneficiary picks it up on their own return. The ceiling on that deduction is Distributable Net Income, or DNI. Income distributed to a beneficiary keeps its character, so qualified dividends stay qualified dividends on the beneficiary’s Form 1040.⁷

Capital gains are treated differently, and this is where trustees get caught. By default under federal law, capital gains allocated to principal are excluded from DNI.⁹ They stay inside the trust and are taxed at the compressed rates, even if the trustee has already sent cash to the beneficiary.

There are exceptions. Capital gains can be included in DNI, and therefore distributed and deducted, if any of the following applies:⁹

The gains are paid, credited, or required to be distributed to a beneficiary during the tax year.
The trust instrument directs that gains be treated as distributable income rather than principal.
State law permits the trustee to allocate gains to income and the trustee does so consistently.

Read the document before assuming gains can be pushed out. If the instrument is silent or locks gains into corpus, the trustee is stuck with the trust-level rate. When gains are properly included in DNI and distributed, they land on the beneficiary’s Schedule K-1, which breaks out ordinary income, short-term gains, and long-term gains separately. A beneficiary sitting in the 12% bracket with long-term gains below the individual 0% threshold owes nothing on that gain.

Document everything. If the IRS questions whether a capital gain was properly distributable, the burden is on the trustee to show that the trust document or state law authorized it.

The 65-Day Election as a Backstop

Trustees often don’t know the trust’s final taxable income until well after December 31. Section 663(b) lets a trustee treat distributions made in the first 65 days of the new tax year as if they were made on the last day of the prior year.¹⁰ For a calendar-year trust, that deadline is March 6 in a normal year and March 5 in a leap year. A February distribution can pull income out of the prior year’s return.

The election is made each year it’s used and does not carry over.¹¹ A trustee who realizes in January that December held an unexpectedly large gain still has room to distribute and shift the tax to the beneficiary. Miss the 65-day window and the tax has already been paid at trust rates.

Filing, Estimated Payments, and Penalties

Form 1041 is due by the 15th day of the fourth month after the trust’s tax year ends. For a calendar-year trust that’s April 15.¹² An extension to file is not an extension to pay; tax owed is still due by the original deadline.

The failure-to-file penalty is 5% of unpaid tax per month or partial month, capped at 25%. If the return is more than 60 days late, the minimum penalty is the smaller of $525 or 100% of the unpaid tax.¹³ A separate 0.5% per month failure-to-pay penalty runs alongside it, and the IRS charges interest on both.

Trusts expecting to owe $1,000 or more after credits and withholding generally need to make quarterly estimated payments on Form 1041-ES, following the same quarterly schedule as individual estimated taxes. A large late-year capital gain with no corresponding estimated payment is a common trigger for the underpayment penalty. If a distribution to a beneficiary is on the table, running it through before year-end (or under the 65-day election) can prevent the underpayment problem and the trust-level rate at the same time.

1
Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1 (2025) – Section: General Instructions
2
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
3
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
4
Internal Revenue Service. Rev. Proc. 2025-32
5
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
6
Internal Revenue Service. Net Investment Income Tax
7
Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1 (2025)
8
Internal Revenue Service. About Form 1041, U.S. Income Tax Return for Estates and Trusts
9
Office of the Law Revision Counsel. 26 U.S. Code 643 – Definitions Applicable to Subparts A, B, C, and D
10
Office of the Law Revision Counsel. 26 USC 663 – Special Rules Applicable to Sections 661 and 662
11
eCFR. 26 CFR 1.663(b)-1 – Distributions in First 65 Days of Taxable Year
12
Internal Revenue Service. Forms 1041 and 1041-A: When to File
13
Internal Revenue Service. Failure to File Penalty