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Trust Law/Level VIII · Trusts of the world/8.3 Running a trust/Lesson 4

Trust taxation: who pays the income tax

Who pays US federal income tax on trust income, the grantor, the trust or the beneficiary, and how the UK taxes trust income and trust property in England and Wales.

Education, not legal advice. Trust law changes from country to country and state to state, and the right structure depends on your situation. Anything you sign should be drafted or reviewed by a qualified lawyer where you live.

The lean path

The cheapest, lowest-tax, simplest and most private route the law allows, best first. Each step names the rule it rests on and the condition that keeps it lawful.

  1. A grantor trust adds no tax layer: the grantor reports its income (IRC §§671-679), and most revocable trusts use the IRS optional method with no Form 1041 (Treas. Reg. §1.671-4). Catch: the grantor pays tax even on income the trust keeps.
  2. Distribute rather than accumulate: a non-grantor trust reaches 37% above $16,000 of taxable income in 2026, against $640,600 for a single individual, and distributions up to DNI move the tax to beneficiaries (§§661-662). Catch: beneficiaries report that income via Schedule K-1.
  3. Use the 65-day rule: distributions within 65 days after year-end can be elected as made in the prior year (IRC §663(b)), trimming retained income and the 3.8% NIIT, which for trusts starts at $16,000 in 2026. Catch: elect on a timely Form 1041.
  4. Capital gains usually stay in the trust: in 2026 trusts pay 0% on long-term gains up to $3,300, 15% to $16,250, then 20%. In-kind distributions avoid trust gain unless the trustee elects otherwise (IRC §643(e)). Catch: the beneficiary takes the low basis.
  5. UK: income up to £500 is normally tax-free in discretionary and accumulation trusts, and interest-in-possession trusts pay 20%, or 10.75% on dividends from 6 April 2026, instead of 45% or 39.35%. Catch: settlor-interested trust income is the settlor’s tax.

MaterialsIRS Instructions for Form 1041, free on irs.govRev. Proc. 2025-32, including the 2026 tax rate table for estates and trusts, free on irs.govThe GOV.UK pages ‘Trusts and Income Tax’ and ‘Trusts and Inheritance Tax’

Wonder

  1. Why does a non-grantor trust reach its top tax rate at a much lower income than an individual?
  2. How does distributable net income (DNI) keep the same income from being taxed to both the trust and the beneficiary?
  3. Which powers or interests held by a settlor make a US trust a grantor trust?

Explore

  1. In the US, federal income tax on trusts is governed by Subchapter J of the Internal Revenue Code (IRC); state law creates the trust, but federal law decides who pays. Under the grantor trust rules (§§671-679), if the settlor (the ‘grantor’) holds certain powers or interests, the grantor includes the trust’s income, deductions and credits on their own return. Examples include a power to revoke (§676), a right to income (§677), certain reversionary interests (§673), powers over beneficial enjoyment (§674) and certain administrative powers (§675). A revocable trust is therefore normally a grantor trust, and the Form 1041 instructions let most such trusts report under the grantor’s own taxpayer number. Some irrevocable trusts are also grantor trusts (lesson 5.1.5). This lesson explains the rules and gives no tax advice.
  2. A trust that is not a grantor trust is a separate taxpayer: IRC §641 imposes tax on its taxable income, and it files Form 1041 for any year with taxable income, gross income of $600 or more, or a nonresident alien beneficiary (lesson 2.2.4). Its brackets are compressed. Under Rev. Proc. 2025-32, for tax years beginning in 2026 a trust’s taxable income is taxed at 10% up to $3,300, 24% up to $11,700, 35% up to $16,000 and 37% above $16,000. For a single individual, the 37% rate begins above $640,600. For trusts, long-term capital gains and qualified dividends are taxed at 0% up to $3,300, 15% up to $16,250 and 20% above. These figures are adjusted for inflation each year.
  3. Distributable net income (DNI), defined in IRC §643(a), measures how much of a trust’s income can be carried out to beneficiaries. Under §§651-652 (trusts required to distribute all income currently) and §§661-662 (other trusts), the trust deducts amounts distributed, up to DNI, and beneficiaries include the same amounts in their own income, generally keeping its character; tax-exempt interest, for example, stays tax-exempt. This ‘conduit’ approach taxes income once: to the trust if retained, to beneficiaries if distributed. Capital gains are generally excluded from DNI and taxed to the trust, subject to exceptions in the regulations. Under §663(b), a trustee may elect to treat distributions made within 65 days after the tax year ends as made in that year.
  4. IRC §1411 imposes a 3.8% net investment income tax (NIIT). For a trust, it applies to the lesser of undistributed net investment income or adjusted gross income above the dollar amount at which the highest income tax bracket begins, which is $16,000 for 2026. For a single individual, the threshold is $200,000 of modified adjusted gross income, an amount set in the statute and not indexed for inflation. A grantor trust’s income is taxed to the grantor, and trusts exempt from income tax, such as charitable remainder trusts, are not subject to the NIIT. Because distributed income is generally taxed to beneficiaries, whether income is distributed or retained affects both the regular tax and the NIIT on it.
  5. In the UK, including England and Wales, income tax depends on the type of trust. According to GOV.UK, the settlor is responsible for income tax on a settlor-interested trust’s income, although trustees pay it as the income is received. Most accumulation or discretionary trusts pay no income tax on income up to a tax-free amount, normally £500; a settlor with several such trusts has the amount divided between them, with a minimum of £100 each for 5 or more. Above it, trustees pay 39.35% on dividend-type income and 45% on other income. Trustees of an interest in possession trust, in which a beneficiary is entitled to the income, pay 20% on most income and 10.75% on dividend-type income (8.75% on or before 5 April 2026). Rates change, so the tax year matters.
  6. UK inheritance tax applies separately. According to HMRC guidance, most property held in trust is ‘relevant property’. When lifetime transfers into most kinds of trust exceed the £325,000 nil-rate band, inheritance tax is due on the excess, at 20% if the trustees pay. Relevant property trusts can then face a charge on each 10-year anniversary of the trust’s creation on value above the available nil-rate band, at an effective rate of at most 6%, and an ‘exit charge’ of up to 6% when property leaves the trust. Some trusts are outside this regime, such as interest in possession trusts created before 22 March 2006 and certain trusts for disabled people and bereaved minors (lesson 8.1.2). Trusts may also face capital gains tax.

Key facts

  • Under IRC §§671-679, the grantor reports a grantor trust’s income, deductions and credits; a revocable trust is normally a grantor trust (§676).
  • A US non-grantor trust is a separate taxpayer (IRC §641) and files Form 1041 if it has any taxable income, gross income of $600 or more, or a nonresident alien beneficiary.
  • Under Rev. Proc. 2025-32, a US trust’s taxable income above $16,000 is taxed at 37% for 2026; for a single individual, 37% begins above $640,600.
  • Under IRC §§651-662, a trust deducts distributions up to distributable net income (DNI), and beneficiaries include those amounts in their own income.
  • IRC §1411’s 3.8% NIIT applies to the lesser of a trust’s undistributed net investment income or its AGI above the start of its top bracket ($16,000 for 2026).
  • In the UK, discretionary trusts pay 39.35% on dividend-type income and 45% on other income above a tax-free amount of normally £500; relevant property faces a 10-year inheritance tax charge of at most 6%.

Exercise nine, six, three, one

9CollectList up to 9 facts about how a trust’s income is taxed, from this lesson or an official source you are reading (some sources give fewer), such as who holds a power to revoke, the trust’s taxable income, the amount distributed, its net investment income and the type of UK trust.
6ClusterSort them into 6 categories: grantor trust status, US trust tax brackets, distributions and DNI, net investment income tax, UK income tax, and UK inheritance tax.
3DistillReduce the 6 categories to 3 groups: facts that decide who is taxed, facts that decide the rate, and facts that decide when tax is charged.
1CrystallizeWrite 1 sentence explaining, in your own words, why income retained by a US non-grantor trust can bear a higher tax rate than the same income received by an individual beneficiary.

Fact check

Dates, figures and claims checked against the published sources listed below.

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