Trust distributions: Timing, tax, and practical considerations

Distributions from a trust to a beneficiary can take many forms and can have widely varying consequences. The timing of the distribution, the type of asset distributed, the requirements under the governing trust instrument, and the intersection of trust accounting income (TAI) and distributable net income (DNI) all combine to add complexity in determining the resulting implications to both the trust making the distribution and the beneficiary receiving the distribution.

In the simplest of terms, a trust distribution represents the transfer of an asset from the trust itself to or for the benefit of one or more of the beneficiaries of the trust. For income tax purposes, a deduction is allowed for certain amounts distributed. Appropriately, this is referred to as an income distribution deduction. This deduction prevents double taxation. When a distribution of taxable income occurs, that income flows out to the beneficiary, essentially removing the income from the trust. The income is reported to the beneficiary on a Schedule K–1, Beneficiary’s Share of Income, Deductions, Credits, etc., of Form 1041, U.S. Income Tax Return for Estates and Trusts, shifting the reporting and taxpaying obligation from the trust to the beneficiary.

As stated in Sec. 661(a), which addresses the deduction for estates and trusts accumulating income or distributing corpus, there shall be allowed as a deduction in computing the taxable income of an estate or trust the sum of:

This one small section of the Code and some related concepts highlight several terms and phrases that must be understood in order to comprehend the overall distribution framework for both the trust and the beneficiaries, including “accumulating income,” “corpus,” “income,” “taxable income,” “required to be distributed currently,” “other amounts properly paid or credited,” and “distributable net income.”

While other related concerns are beyond the scope of this article — the mathematical computations of the amounts required to be distributed under the trust instrument, the income distribution deduction to the trust, and the amount includible in the taxable income of the beneficiary — the concepts that are fundamental to understanding how these computations work are discussed, along with some recent statutory developments that may affect them.

Source of distributions: Income vs. corpus

Income and corpus represent two fundamental concepts of trust accounting and taxation, with both terms appearing throughout Subchapter J of the Internal Revenue Code.¹ Distributions may be made from either income or corpus or from a combination of both. Identifying the source from which a distribution originates is necessary in determining the amount of taxable income that will be passed out to a beneficiary. It is important to note that, while these terms appear in the Code and regulations, these are fiduciary accounting concepts.

At a high level, the term “income” refers to the earnings generated by the trust’s underlying assets. This includes items typically associated with “income” in the general sense of the word, such as interest, dividends, and rents received. Income can have different meanings depending on the context in which it is used. In Subchapter J, the term “income” is defined as follows:

Income. For purposes of this subpart and subparts B, C, and D, the term “income,” when not preceded by the words “taxable,” “distributable net,” “undistributed net,” or “gross,” means the amount of income of the estate or trust for the taxable year determined under the terms of the governing instrument and applicable local law. Items of gross income constituting extraordinary dividends or taxable stock dividends which the fiduciary, acting in good faith, determines to be allocable to corpus under the terms of the governing instrument and applicable local law shall not be considered income.²

This definition highlights the importance of the trust instrument and state law in determining what constitutes income. It also highlights the importance of identifying the type of income in question. For instance, income not preceded by the words “taxable,” “distributable net,” “undistributed net,” or “gross” refers to a fiduciary accounting concept, which may vary depending on the trust instrument itself and the situs under which the trust was drafted. Certain common expenses such as trustee fees, investment advisory fees, and accounting fees, among others, are often allocated 50/50 between income and corpus. The different types of income will be described later in this article. Distributions of income typically carry out DNI to beneficiaries.

Corpus, often referred to as principal, represents the underlying assets of a trust from which income is generated. While corpus is not specifically defined in the Code in the same manner as income, it can be seen as everything not classified as income under fiduciary accounting. Certain items such as capital gains are often allocated to corpus under many trust instruments and state law, though these could be allocated to income as well. Corpus includes the initial trust funding, subsequent contributions, the unrealized appreciation of those assets, and the subsequent receipts that are allocated to corpus over the life of the trust. Distributions of corpus do not generally carry out DNI to beneficiaries.

Trust accounting income, distributable net income, and taxable income

A trust is required to calculate three types of income: TAI, DNI, and taxable income. They each serve different functions within the distribution framework of a trust and, as a result, are rarely the same. TAI dictates required distributions; DNI limits the amount of taxable income available to be passed out to beneficiaries; and taxable income represents the amount that is not distributed and therefore is taxed in the trust.

Trust accounting income

TAI, also known as fiduciary accounting income, refers to the income of the trust as determined under the governing trust instrument and state law. TAI provides the amount trustees must reference in determining the amount of income required to be distributed currently to beneficiaries.

Because TAI is primarily derived from actual cash inflows and outflows and follows fiduciary accounting principles rather than tax law, it more accurately reflects the economic reality of the trust and thus provides fiduciaries with a more accurate measure of the amount available for beneficiary distributions. TAI is critical for simple trusts, which are required to distribute income currently.

Where the trust agreement is silent, TAI is determined under state law. Many states have adopted some form of the Uniform Fiduciary Income and Principal Act, which provides a framework for categorizing and allocating receipts and disbursements between income and principal.

Distributable net income

DNI is a federal tax concept that represents the amount of taxable income available to be distributed, or carried out to beneficiaries. To elaborate, DNI serves as a limit to the deduction allowed to the trust for amounts distributed to beneficiaries (the income distribution deduction) and, correspondingly, limits the amount that beneficiaries must include in income.

DNI is calculated by making modifications to taxable income such as adding back the values of the income distribution deduction, fiduciary income tax exemption, and tax–exempt interest and subtracting net capital gains.

The amounts actually distributed to beneficiaries may be greater than the calculated DNI value, but the amount of the income distribution deduction will be limited to DNI. For example, suppose for a tax year that the amount of calculated DNI for a trust is $50,000, but the trustee distributes $100,000 to the beneficiary. Even though a distribution of $100,000 is actually made to the beneficiary, the income distribution deduction — and correspondingly, the amount includible in the beneficiary’s income — is limited to $50,000.

Taxable income

Taxable income, as alluded to above, is simply the gross taxable income of the trust less the trust’s total allowable deductions as calculated on Form 1041. As previously mentioned, DNI is a derivative of taxable income and is a component of the income distribution deduction, which is taken into account in arriving at taxable income. Taxable income represents the amount of income that is ultimately taxed at the trust level.

Types of distributions

Identifying the type of distribution is essential in determining the amount of deduction allowed to the trust and the amount of income recognized by the beneficiary. Broadly speaking, beneficiary distributions fall into three major buckets: required distributions, discretionary distributions, and pecuniary bequests.

Required distributions

Required distributions refer to those distributions of income that are required to be distributed currently. In nearly all cases, “income required to be distributed currently” refers to TAI, not taxable income. This is an important nuance and must be taken into consideration when determining both the actual amount of cash to be distributed and the corresponding deduction allowed to the trust.

In the case of required distributions, the grantor of the trust essentially determines and establishes the amounts of future distributions to be made to beneficiaries at the time the trust document is executed. The trustee simply makes distributions to beneficiaries as directed by the trust instrument. An example of the language that might be found in a trust agreement for this type of distribution standard is as follows: “The Trustee shall distribute the entire net income of the trust to the beneficiary at least annually or in more frequent installments.”

While Sec. 661, referenced previously, concerns estates and trusts accumulating income or distributing corpus, Sec. 651 addresses trusts distributing current income only, or in other words, simple trusts making only required distributions, not discretionary distributions as well. For these trusts, there shall be allowed as a deduction in computing taxable income of “the amount of the income for the taxable year which is required to be distributed currently,”³ but “[i]f the amount of income required to be distributed currently exceeds the distributable net income of the trust for the taxable year, the deduction shall be limited to the amount of the distributable net income.”⁴

Unique to simple trusts, where income is required to be distributed currently, the amount required to be distributed will be treated as distributed for income tax purposes whether actually distributed or not.⁵ This is important to be aware of, as there could be instances where beneficiaries do not receive distributions for one reason or another but, for tax purposes, are still required to report and pay tax on the amount required to be distributed to them under the trust instrument. To illustrate, suppose a simple trust has $50,000 of TAI for the year, all of which is required to be distributed currently under the trust instrument. In this example, there are no differences between TAI and taxable income. Due to unforeseen administrative issues, the trustee does not make the required distributions of income during the year. For income tax purposes, the beneficiary will still be treated as having received the $50,000 and must report it as taxable income.

Discretionary distributions

Discretionary distributions refer to those distributions properly paid or credited to a beneficiary that are not required under the terms of the trust instrument. Unlike required distributions, which are dictated by and clearly defined in the trust agreement, these distributions are made at the trustee’s discretion. Discretionary distribution standards will vary from trust to trust but typically fall into two broad categories (or some combination of these two categories):

1. Ascertainable standard: Distributions subject to an ascertainable standard are those where some level of guidance is provided to the trustee in making distributions, such as the HEMS standard allowing for distributions for the beneficiary’s health, education, maintenance, and support (HEMS). The HEMS standard falls within the definition of an ascertainable standard under Sec. 2041(b)(1)(A) and Sec. 2514(c)(1).
   
   An example of the language that might be found in a trust agreement for this type of standard is as follows: “The Trustee may distribute to or for the benefit of the beneficiary such amounts of income or principal as the Trustee determines are necessary for the beneficiary’s health, education, maintenance, and support.”
2. Fully discretionary standard: Distributions subject to a fully discretionary standard, or a nonascertainable standard, are those where the trustee is afforded absolute discretion in determining the amount and the timing of distributions to or for a beneficiary.
   
   An example of the language that might be found in a trust agreement for this type of standard is as follows: “The Trustee may distribute to or for the benefit of the beneficiary such amounts of income or principal as the Trustee, in the Trustee’s sole and absolute discretion, determines to be appropriate.”

In the case of discretionary distributions, the amount of the income distribution deduction is not limited to TAI. Rather, the deduction is limited to the lesser of DNI or the actual amount distributed. Contrasting with required distributions, the actual amount distributed must always be considered when determining the deduction allowed for discretionary distributions, as there is no deemed distribution based on TAI.

Pecuniary bequests

Often, especially in the case of estates, specific dollar amounts or specific assets are bequeathed to beneficiaries. This type of distribution is referred to as a pecuniary bequest. Unlike required distributions and discretionary distributions, there is no income distribution deduction for a pecuniary bequest. This is specifically excluded under Sec. 663(a)(1). Likewise, a pecuniary bequest does not carry out income to the beneficiary.

One important subtlety relating to pecuniary bequests is the potential for gain recognition under certain circumstances. If a pecuniary bequest is satisfied by distributing appreciated assets (assets with a higher fair market value (FMV) than their adjusted basis) rather than cash, the trust must recognize gain on the difference between the adjusted basis of the assets and the FMV of the assets at the time of the distribution. This is commonly referred to as Kenan gain.⁶

Charitable distributions

Charitable distributions fall in a no–man’s land in the context of trust distributions. Distributions to charitable organizations are not beneficiary distributions, but they also do not represent payments of trust expenses or trust obligations. These payments are distributions to a nonbeneficiary charitable organization made at the discretion of the trustee. Sec. 642(c) allows for a deduction in computing the taxable income of the trust if the payment to the charitable organization is made out of gross income and is made pursuant to the terms of the governing instrument. However, it is very important that the trust agreement authorizes the trustee to make charitable distributions. Making such distributions otherwise could be seen as a breach of the trustee’s fiduciary duty since the trustee would be taking amounts set aside for beneficiaries and distributing those amounts to nonbeneficiary third parties.⁷

Because a separate deduction is allowed for the amount distributed to the charitable organization under Sec. 642(c), an income distribution deduction is not also allowed. Charitable distributions are specifically excluded as qualifying distributions for the income distribution deduction under Sec. 663(a)(2).

Elections

As illustrated thus far, the distribution rules of Subchapter J are intricate, and scenarios often arise in which the timing and/or characterization of a distribution does not produce the desired tax outcome. Fortunately, the rules of Subchapter J are supplemented by several elections that can provide relief as well as meaningful planning opportunities.

Sec. 663(b): 65-day election

Sec. 663(b) allows a trustee to elect to treat distributions made within the first 65 days of the trust’s tax year as paid or credited on the last day of the preceding tax year. This provides great flexibility to the trustee, as it allows him or her to wait until the actual results of the prior tax year are known, including DNI, before making final distributions.

The election is made by making the actual distribution within the first 65 days of the year following the tax year to which the election applies and by checking a box and reporting the appropriate amounts as distributions on the trust’s income tax return.

Sec. 643(g): Election to apply estimated tax payments to beneficiaries

Sec. 643(g) allows a trustee to elect to treat any portion of a payment of estimated tax made by a trust for any tax year as being made by a beneficiary of the trust.

This can be especially important when estimated tax payments are being made under the safe–harbor method,⁸ when income at the trust level is lower than expected, or income at the beneficiary level is greater than expected. The amount is treated as paid or credited to the beneficiary on the last day of the tax year and shall be treated as a payment of estimated tax by the beneficiary on Jan. 15 of the following year. The election is made by filing Form 1041–T, Allocation of Estimated Tax Payments to Beneficiaries, by the 65th day after the close of the tax year.

Sec. 643(e)(3): Election to recognize gain on in-kind distributions

Sec. 643(e)(3) allows a trustee to elect to treat a distribution of property other than cash (i.e., an in–kind distribution) as if the trust or estate had sold the property to the beneficiary at its FMV at the time of distribution. The trust recognizes gain or loss on the sale, and the beneficiary takes a stepped–up (or stepped–down) basis in the property equal to its FMV.⁹

This can be a very beneficial election when the election results in a gain and there are capital loss carryforwards at the trust level that may go unused, as it allows the trust to transfer property to the beneficiary with a stepped–up basis without any income tax being generated, due to the offsetting capital losses.

The election is made on a timely filed Form 1041 (including extensions) by checking a box and reporting the capital gain and appropriate amounts as distributions.

Sec. 642(c)(1): Election to treat charitable amounts as paid in the previous tax year

Sec. 642(c)(1) allows a trustee to elect to treat amounts paid for charitable purposes, if paid after the close of a tax year and on or before the last day of the year following the close of such tax year, as having been paid during such tax year.

This means the trust is able to calculate taxable income after the close of a tax year and then pay as much of that as the trustee wishes to a charitable organization, eliminating all or a portion of taxable income via the charitable deduction allowed.

The election is made by filing a statement with the income tax return (or amended return) for the tax year in which the contribution is treated as paid and should include information as specified in Regs. Sec. 1.642(c)-1(b)(3).

To retain or not to retain

While trusts may seem complicated at times or even administratively burdensome, they can provide great flexibility and planning opportunities from an income tax perspective. Whether income is taxed to the trust or to the beneficiary can produce significantly different tax results. As such, the ability to choose to retain income in the trust or distribute it to the beneficiaries can be a powerful tool to trustees.

Income tax rate optimization: Trusts reach the top federal income tax brackets much more quickly than individuals do. For instance, for 2026, a trust reaches the top ordinary income tax bracket of 37% once taxable income exceeds $16,000. An individual, however, reaches the top ordinary income tax bracket once taxable income exceeds $640,600 for single taxpayers and $768,700 for married couples filing jointly.

Depending on other sources of income and domicile considerations, and assuming the beneficiary is in a lower tax bracket, making a distribution to the beneficiary could produce significant tax savings by shifting the income from the higher tax rate of the trust to the lower tax rate of the beneficiary.

State income tax minimization: State income tax planning opportunities may exist, depending on the beneficiary’s state of residence, along with the trust’s state of domicile. Since the trust is treated as a separate taxpayer for income tax purposes, making distributions to a beneficiary in a state with more taxpayer–friendly income tax rules may be possible. For example, a trustee of a trust domiciled in a state with a high income tax rate may wish to shift income to a state with a lower income tax rate or, perhaps, no income tax at all. Making an income distribution can achieve this.

For state income tax purposes, nondistributed, nonsourced income such as portfolio income is typically sourced to the trust’s state of domicile. Distributions of nonsourced income to the beneficiary, however, would likely be taxable in the beneficiary’s state of residence. As is always the case with multistate planning, the laws of both jurisdictions would need to be reviewed to confirm the actual tax outcomes.

Other sources of income: The ability to retain income in the trust or distribute it to the beneficiary can also provide an opportunity to better align income and expenses. Situations may arise where the trust has significant income and the beneficiary has significant losses.

For example, suppose the beneficiary has significant capital loss carryovers available for use in the tax year but does not have any capital gains for the year and does not foresee capital gains of enough significance to utilize the capital loss carryovers in future tax years. Assume for the same tax year that the trust has significant capital gain income and no offsetting capital losses or capital loss carryovers from prior years. There is obviously a mismatch of income and expenses in this scenario. Assuming the trust agreement allows for discretionary distributions of corpus, though, there may be an opportunity for the trustee to distribute the capital gains to the beneficiary as part of a discretionary principal distribution, allowing the capital loss carryovers to be utilized at the beneficiary level.

The previously discussed Sec. 663(b) election can prove to be very valuable in this exact scenario, as it allows both the trustee and the beneficiary to determine the year’s taxable income amounts prior to making final distributions. It is important to note that, except in the case of a terminating trust, net losses cannot be distributed.

State income tax inefficiency and accumulation distribution tax: Contrasting with a trust domiciled in a high income tax state making distributions to a beneficiary in a low income tax state, a trust domiciled in a low income tax state — or a state with no income taxes — making distributions to a beneficiary in a high income tax state can have negative tax implications. The obvious one, which is often unavoidable, is simply shifting income to the beneficiary, resulting in the income being taxed at a higher rate.

While not common among states, a distribution of previously untaxed income to the beneficiary may also, depending on the beneficiary’s state of residence, trigger some form of an accumulation distribution tax or “throwback tax,” causing the previously untaxed amounts included in the distribution to become immediately taxable in the beneficiary’s state of residence. This could be unexpected and costly to the beneficiary. California is an example of a state that has a version of this rule.¹⁰

In-kind distributions: A trustee may choose to make a distribution of property rather than cash. This is referred to as an in–kind distribution, as previously mentioned. Absent an election under Sec. 643(e)(3), the amount of the distribution for income tax purposes is the lesser of the trust’s adjusted basis in the property immediately before distribution or the property’s FMV.¹¹ As a result, there may be instances where the trustee wishes to distribute a certain amount to the beneficiary and wishes to do so by distributing an asset whose FMV approximates that desired amount. Assuming the trust agreement allows this, satisfying the distribution with property rather than cash does not inherently present any issue. However, if the basis in the distributed asset is significantly less, the amount of DNI that flows out to the beneficiary will reflect this lower basis amount, potentially causing more income to be taxed inside the trust than intended.

In the case of a discretionary distribution, it may make more sense to distribute cash if the intention is for the amount of DNI that flows out to more closely mirror the actual economics of the distribution. Additionally, if the distributed asset does not have an easily ascertainable FMV, a valuation may be required to determine the amount of the distribution for income tax purposes.

Other distribution-related considerations

Grantor trusts

It is important to note that in the case of a trust meeting the definition of a grantor trust as determined under Secs. 673–678, a distribution will have no impact on the income tax treatment of the trust or the beneficiary. This is because all items of income, deductions, and credits against tax of the trust are taxed directly to the grantor under Sec. 671 regardless of distributed amounts.

Terminating trusts

In the case of a terminating trust, actual amounts distributed will not necessarily be relevant in determining the distribution amount for income tax purposes. During the termination period, the trust’s income and capital gains are generally treated as income required to be distributed in the year received.¹² As a result, all DNI will be deemed distributed to the beneficiary on the final–year income tax return. This is true even if the actual amount of cash and other assets available to distribute is less than DNI.

Recent developments

It is important to note that recently enacted legislation — specifically, H.R. 1, P.L. 119–21, commonly known as the One Big Beautiful Bill Act (OBBBA), signed into law July 4, 2025 — may affect certain elements of trust distributions and the related deductions discussed in this article. The impact is still uncertain and a topic of debate among practitioners, but there is a belief among some that deductions under Secs. 642, 651, and 661 could be limited due to revisions to Secs. 67 and 68.

The OBBBA modified Sec. 67 to permanently suspend the deduction for miscellaneous itemized deductions¹³ and repealed Sec. 68(e), which expressly provided that the overall limitation on itemized deductions under Sec. 68 did not apply to estates and trusts. Sec. 68(a), as newly enacted, provides that for taxpayers in the highest ordinary income tax bracket, otherwise allowable itemized deductions shall be reduced by a 2/37 fraction. This has led to debate as to whether certain deductions allowed under Secs. 642, 651, and 661 should now be construed as itemized deductions and therefore subjected to the limitations imposed under Sec. 68. If, in fact, this interpretation were to be adopted, one major implication would be double taxation — the income distribution deduction to the trust could be limited, causing the trust to pay tax on a portion of the income it distributed, while the beneficiary would pay tax on the full amount of income received.

While some assert that these deductions should be classified as itemized deductions under the new law, others continue to cite Sec. 67(e), in conjunction with Regs. Sec. 1.67-4(a)(1)(ii) and prior IRS guidance, as support for the treatment of the Sec. 642(b) personal exemption and the Sec. 651/661 distribution deductions as above-the-line deductions rather than itemized, placing them outside the purview of Sec. 68. Additionally, uncertainty exists surrounding the treatment of Sec. 642(c) charitable amounts and whether such amounts should be subject to Sec. 68 as well. Further guidance is needed to determine the exact application of the new law, but the important takeaway is that this legislation could have an impact on certain trust–level deductions.

Monitoring distributions

In summary, careful consideration is required in both making distributions from a trust and accounting for them. The types of assets distributed, the timing of distributions, and the requirements under the trust instrument and state law should be continually evaluated. With the right planning in place and proper forethought, the trustee can maximize tax efficiency for both the trust and the beneficiary, as well as prevent unplanned outcomes.

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Footnotes

¹Of Subtitle A, Chapter 1, Secs. 641–692.

²Sec. 643(b).

³Sec. 651(a), flush language.

⁴Sec. 651(b).

⁵Sec. 652(a).

⁶Kenan, 114 F.2d 217 (2d Cir. 1940).

⁷See Strausfeld, “Being Philanthropic With a Noncharitable Trust,” Journal of Accountancy (Aug. 9, 2023).

⁸Payment of 90% of the tax shown on the current-year return and 100% of the tax shown on the previous year’s return (Sec. 6654(d)(1)(B)).

⁹See Jourdier, “Trust Distributions in Kind and the Sec. 643(e)(3) Election,” 57-1 The Tax Adviser 40 (January 2026).

¹⁰Id.

¹¹Sec. 643(e)(2).

¹²Regs. Sec. 1.641(b)-3.

¹³Sec. 67(h).

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Contributor

Douglas Yost, CPA, is a partner with Navolio & Tallman LLP in Walnut Creek, Calif. For more information about this article, contact thetaxadviser@aicpa.org.

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