Trust income taxation encompasses the rules governing how trusts are taxed on income they earn from investments, business interests, and other assets. Non-grantor trusts are treated as separate taxpayers, subject to highly compressed income tax brackets, while grantor trusts are generally taxed to the grantor as if the trust does not exist for income tax purposes. Trusts may receive dividend, interest, rental, and capital gain income, and special rules apply to tax-exempt income and unrelated business taxable income. Choosing between grantor and non-grantor status, and managing distributions, directly influences the total taxes paid by the family, making trust income taxation a central consideration in estate and wealth transfer planning.

Advisors discuss trust income taxation when designing irrevocable trusts to own life insurance, investment portfolios, or closely held business interests. They collaborate with tax counsel to determine whether a trust should be intentionally structured as a grantor trust to allow the grantor to pay income taxes, effectively making additional tax-free gifts to beneficiaries. In other cases, non-grantor status is preferred to shift income to beneficiaries in lower brackets. Advisors also consider how trust taxation interacts with state income taxes and residency rules. Understanding trust income taxation enables advisors to align insurance and investment structures with the desired balance of control, asset protection, and long-term tax efficiency.