By Harry Prabandham · Updated September 28, 2026
Tax Planning
Trust Tax Rates: Managing Compressed Brackets
Non-grantor trusts hit the 37% bracket above $16,000 of taxable income in 2026. Distributions, the 65-day election, and grantor status shift the tax.
Trust Tax Rates: Managing Compressed Brackets
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Why are trust tax rates so high?
- A non-grantor trust's retained income is taxed on compressed brackets: in 2026, 10% to $3,300, 24% to $11,700, 35% to $16,000, then 37%.
- A single filer does not reach 37% until $640,600 of taxable income in 2026, or $768,700 for joint filers.
- Trust long-term gains hit the 20% rate above $16,250, and the 3.8% net investment income tax applies above $16,000 of AGI.
- State tax can add more; California's top rate applies to trust income taxable there.
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Full Guide
Why are trust tax rates so high?
- A non-grantor trust's retained income is taxed on compressed brackets: in 2026, 10% to $3,300, 24% to $11,700, 35% to $16,000, then 37%.
- A single filer does not reach 37% until $640,600 of taxable income in 2026, or $768,700 for joint filers.
- Trust long-term gains hit the 20% rate above $16,250, and the 3.8% net investment income tax applies above $16,000 of AGI.
- State tax can add more; California's top rate applies to trust income taxable there.
How do distributions shift the tax?
- Distributions generally carry out distributable net income, or DNI, to beneficiaries, and the trust deducts what it distributes.
- Beneficiaries then report that income on their own returns, often at lower rates than the trust's.
- Simple trusts must distribute all income each year; complex trusts give the trustee discretion.
- Distribution decisions must follow the trust document and the trustee's fiduciary duties, not only tax savings.
What is the 65-day election?
- Under Section 663(b), a trustee can elect to treat distributions made in the first 65 days of a year as made in the prior year.
- That lets the trustee size distributions after the prior year's income is known.
- The election is made on the trust's Form 1041 by its due date, including extensions, and is irrevocable for that year.
- Estates can use the election as well; confirm the amount and mechanics with the trust's CPA.
How does grantor trust status change the math?
- Income of a grantor trust is taxed to the grantor at individual rates, so the compressed trust brackets do not apply.
- The IRS has ruled that the grantor paying that income tax is not a gift to the beneficiaries.
- An intentionally defective grantor trust can be outside the grantor's estate for estate tax while remaining a grantor trust for income tax.
- The grantor must be able to keep paying the tax, and some trusts allow grantor status to be turned off later.
Are capital gains in a trust taxed to the trust?
- Usually yes: capital gains are generally excluded from DNI and taxed to the trust.
- Regulations allow gains to be included in DNI in limited cases, such as when the document or state law allocates them to income, or a consistent trustee practice.
- Because gains retained in the trust reach the top rate quickly, when gains are realized matters.
- Review the trust instrument before assuming gains can be passed out to beneficiaries.
How do states tax trusts?
- States use different connections, such as where the grantor lived, where trustees live, where the trust is administered, or where beneficiaries live.
- California taxes trust income based on resident fiduciaries and resident non-contingent beneficiaries.
- The Supreme Court held in Kaestner (2019) that a state could not tax a trust based only on a beneficiary's residence in the circumstances presented.
- Nevada, South Dakota, and Wyoming have no personal income tax, which is one reason trusts are sited there.
Key takeaways
- Retained trust income reaches 37% above $16,000 in 2026, versus $640,600 for single filers.
- Distributions, the 65-day election, and grantor status can move income to lower rates.
- Capital gains usually stay in the trust, so gain timing matters.
- Trust tax and state residency questions call for a CPA and trust attorney.
Related Topics
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A trustee must follow the trust, act loyally and prudently, inform beneficiaries, and file tax returns. In 2026, trust income over $16,000 is taxed at 37%.
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Sources
- IRS Rev. Proc. 2025-32 — 2026 brackets for estates and trusts
- IRS — About Form 1041, U.S. Income Tax Return for Estates and Trusts
- 26 U.S.C. § 663 — Special rules applicable to sections 661 and 662 (65-day election)
- 26 CFR § 1.643(a)-3 — Capital gains and losses in DNI
- North Carolina Dept. of Revenue v. Kimberley Rice Kaestner 1992 Family Trust (2019)