Is Money from a Trust Fund Considered Income?

When working with clients to establish a trust, a common question raised is: is money from a trust fund considered income? The answer is - it depends. There are important variables that need to be considered when assessing whether funds from a trust are actually “income” and therefore subject to income tax. For example, certain types of trust distributions may be considered income (and therefore taxable), while others may not. In this blog, our estate planning firm explains how income from a trust works, and how you can manage your funds correctly.

Before deep diving into trust fund income issues, let’s discuss how trusts typically work.

Overview of How Trusts Work

Trusts are legal instruments that can be utilized for an array of financial and estate planning purposes. In terms of establishing a trust, there needs to be a grantor (i.e., the individual who formally creates the trust), the trustee (i.e., the individual responsible for managing the assets in the trust), and a beneficiary or beneficiaries (i.e., the person, or people, who will benefit from the assets managed in the trust).

Once a trust is established, assets will need to be formally transferred from the grantor to the trust itself. For example, if a grantor has real estate and stock options they’d like managed through the trust, they would need to transfer their ownership interest in those assets to the trust. This separation of legal ownership is necessary and allows the grantor to leave specific instructions on how those assets should be used and distributed to beneficiaries. The trustee will be tasked with managing and administering the trust in accordance with the stated wishes and directives of the grantor.

There are many different types of trusts, but the two main distinctions are: revocable trusts and irrevocable trusts.

A revocable trust is effectively a modifiable trust whereby the grantor has the ability to alter or cancel at any point in their life. Revocable trusts are helpful in avoiding the probate process.

In contrast, an irrevocable trust is more akin to a lock box. Once an irrevocable trust is established, it cannot be modified or ended without the consent of the beneficiary, or beneficiaries.

Income from Trust Fund Distributions

The issue of what funds are deemed income arises with trust distributions. In effect, trust fund distributions are assets or income that get passed from the trust to the beneficiary, or beneficiaries. Trust distributions are governed by the specific terms and directives of the trust. For example, some trusts require assets to be distributed outright to beneficiaries in a lump sum. Other trusts require trust property to be retained in trust for a specific period of time before they can be distributed to the beneficiary, or beneficiaries.

Trust property generally falls into two categories: principal (i.e., property transferred to the trust by the settlor) and income (i.e., what is earned by the trust on the principal). Trust distributions can be in the form of cash, stock options, real estate and so forth. For example, if a trust owns a rental property generating monthly income, that rental income would be distributed to the beneficiaries of the trust and would generally be considered a form of income (meaning it may be subject to taxation).

However, the situation gets more complex when it comes to distributions from a trust’s principal. In the event a beneficiary receives distributions from a trust’s principal, they are generally not obligated to pay taxes on the distribution. Basically, this means receiving funds from the trust principal is not considered a form of taxable income. Nevertheless, income generated by the assets maintained in the trust (e.g., interest, dividends, rental payments) are considered to be income, and therefore taxable.

Trust Income and Taxes

As mentioned, when a trust contains income-generating assets, this means beneficiaries need to be prepared to treat those distributions as income that is subject to taxation.

For 2025 taxes (which will be filed in 2026), trust income is subject to four tax levels:

• Level 1: Income between $0 – $3,150 subject to 10% tax rate
• Level 2: Income between $3,150 – $11,450 subject to 24% tax rate
• Level 3: Income between $11,450 – $15,650 subject to 35% tax rate
• Level 4: Income at or above $15,650 subject to 37% tax rate

For example, if a trust generates $8,000 in income during 2025, it would be obligated to pay the following taxes:

• 10% of $3,150 (all earnings between $0 – $3,100) = $315
• 24% of $4,850 (all earnings between $3,101 – $10,000) = $1,164
• Total tax due = $1,479

Contact Our Experienced Estate Planning Law Firm

Trust distributions, as discussed above, can become quite complex and challenging to navigate. When properly configured and managed, a trust can provide financial security, asset protection and tax benefits. However, if a trust is not properly configured or is mismanaged, it can have significant adverse consequences for the beneficiaries. Bespoke Estate Law can help. We are a Myrtle Beach law firm that specializes in estate planning, business law, contract law, and probate & trust administration services. We proudly serve an array of impressive clients residing in Myrtle Beach and surrounding localities.

Contact our Myrtle Beach estate planning law firm today to schedule a free consultation. During the consultation, you will have the chance to speak directly with an attorney, and they will provide guidance on how the firm can assist you in protecting your assets through a trust, securing your legacy, and achieving your legal goals.