Non-grantor trust taxation refers to the income tax rules that apply when a trust, rather than the grantor, is treated as the taxpayer. A non-grantor trust is responsible for reporting and paying tax on its undistributed income at trust tax rates, which reach the highest brackets at much lower income levels than individual rates. When the trust distributes income to beneficiaries, it generally receives a distribution deduction, and the beneficiaries report the income on their own returns, often at potentially lower rates. Capital gains treatment, deductions, and special rules for charitable contributions or complex trust structures can further affect the tax picture. Life insurance held within a non-grantor trust is typically not subject to annual income tax on inside buildup, but side investments, dividends, and interest are subject to non-grantor trust taxation rules. Understanding these rules is critical for designing efficient estate-planning and wealth-transfer strategies.

In practice, non-grantor trust taxation becomes a focal point when attorneys and CPAs recommend shifting income away from a high-bracket grantor or relocating assets for state tax reasons. Insurance advisors encounter these rules when working with irrevocable life insurance trusts or other structures that own both life insurance and taxable investments. They collaborate with tax professionals to ensure premium funding and distribution patterns do not create unexpected tax burdens at the trust level. Discussions often center on whether to retain income in the trust-incurring higher trust rates-or distribute it to beneficiaries taxed at lower individual rates. When reviewing inforce policies, advisors note that while life insurance buildup is generally tax-deferred, any trust-owned side accounts or supplemental investments are fully subject to non-grantor trust taxation. Clear coordination between planning, product selection, and tax reporting is essential to achieving desired outcomes.