What Are Trust Fund Taxes?

If you are not an accountant and you hear the phrase “trust fund taxes,” you probably think first of taxes withheld from employees’ paychecks to pay for Social Security, Medicare, and federal income tax. But today, we’re focusing on a different type of trust fund tax—the taxes on income generated by trust funds.

What are income taxes on trust funds and who pays them?

Any income earned is generally taxable, and trust fund income is no exception. The taxation of a trust depends on whether it is a grantor trust or a non-grantor trust:

• Grantor Trusts: If the grantor (the person who created the trust) retains control over the trust, the IRS considers it a grantor trust. The grantor is responsible for paying income taxes on any income the trust generates, even if that income is distributed to beneficiaries.
• Non-Grantor Trusts: If the grantor does not retain control over the trust's income or assets, it is classified as a non-grantor trust. The trust itself pays taxes on any income it retains, while beneficiaries are taxed on any distributed income.

Grantor Trusts: Tax Treatment and Benefits

All revocable trusts (also known as living trusts) are grantor trusts. Most irrevocable trusts are non-grantor trusts, but there are exceptions, such as intentionally defective grantor trusts (IDGTs).

For grantor trusts:

• The trust is not required to file a separate tax return.
• The income is taxed to the grantor personally, regardless of whether it is distributed to a beneficiary.
• There are tax benefits, such as the ability to loan money to the trust without triggering income tax, and the ability to sell assets within the trust without recognizing capital gains.
• IDGTs allow the grantor to pay taxes on the trust's income while keeping the trust's assets excluded from estate tax.

Non-Grantor Trusts: Tax Obligations

Non-grantor trusts are typically treated as separate tax entities and may have specific filing and reporting obligations. For example:

• They may be required to file Form 1041 with the IRS.
• If income is retained within the trust, it could be taxed according to trust tax brackets.
• If income is distributed to beneficiaries, the trust may issue Schedule K-1 forms, and beneficiaries may be responsible for reporting that income on their tax returns.
• In cases where the trust sells appreciated assets, there may be capital gains implications, especially for assets held longer than a year.\ \ As always, consult a qualified tax advisor to understand how these rules may apply to your situation.

2025 Trust Tax Rates and Brackets

Trusts face higher marginal tax rates at lower income levels than individuals. The 2025 tax rates for trusts are as follows:

Taxable Income $0 - $3,150 - Tax rate 10%

Taxable Income $3,150 - $11,450 - Tax rate $315.00 + 24%

Taxable Income $11,450 - $15,650 - Tax rate $2,307.00 + 35%

Taxable Income Over $15,650 - Tax rate $3,777.00 + 37%

Other Trust-Related Taxes

Estate Taxes: In 2025, estates over $13.61 million (double for married couples) are subject to federal estate tax. Some states also impose estate or inheritance taxes, which vary by jurisdiction.

Deductions Available for Trusts

Under current IRS guidelines, trusts and estates may be eligible for certain tax deductions. These can include:

• A standard exemption amount varies by trust type (e.g., $100 for complex trusts, $300 for simple trusts, and $600 for estates).
• Possible deductions for administrative costs like trustee fees and tax preparation expenses.
• Sometimes, a trust with qualifying business income (QBI) may benefit from a partial deduction, subject to IRS rules and limitations.

Additionally, long-term capital gains may apply when a trust sells appreciated assets, often at favourable rates, if the assets were held for over a year.

*Note: Tax rules can be complex and subject to change. For personalised guidance, it's always best to consult with a qualified tax advisor or estate planning professional.*

Principal Distributions and Tax Treatment

Beneficiaries do not pay taxes on trust distributions made from principal rather than income. These funds were already taxed before being placed in the trust.

Need Life Insurance?

Protect your loved ones with an easy, hassle-free life insurance policy. No medical exam, no waiting—just a quick online application for peace of mind. Get a fast, free quote today!

The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of Ethos Technologies Inc., its affiliates, employees or any other individuals. The information and content provided is for informational purposes only, and it is not to be considered legal, tax, investment, or financial advice, recommendation, or endorsement. You should consult with an attorney or other professional to determine what may be best for your individual needs.

Don’t have Life Insurance? Well we made it easy for you to apply for reliable life insurance through our simplified and streamlined online application process. No exam | Just a few health questions | No waiting | No hassles | Fast, free quote!

Learn more about grantor trust taxation in the IRS instructions for Form 1041