A non-grantor trust pays federal tax on retained capital gains at rates as high as 23.8% on long-term gains and 40.8% on short-term gains, and those top rates kick in once the trust’s taxable income clears just $16,000 in 2026. Trust tax rates on capital gains are so compressed that most retained gains land in the top tier almost immediately. The main way to lower the bill is to distribute the gain to a beneficiary, when the trust document permits it, so the income is taxed at the beneficiary’s individual rates instead.
One boundary before the numbers: this applies to non-grantor trusts, the kind that file their own Form 1041 and pay their own tax. If the trust is a grantor trust, all income and gains flow through to the grantor’s personal 1040 and are taxed at individual rates, so none of the compressed brackets below apply.1Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1 (2025) – Section: General Instructions
Why Trust Brackets Punish Retained Gains
A single individual doesn’t hit the 37% federal bracket until taxable income exceeds $640,600 in 2026.2Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 A trust hits it at $16,000. For 2026, a non-grantor trust’s ordinary income moves through four brackets:3Internal Revenue Service. Rev. Proc. 2025-32
- 10% on taxable income up to $3,300
- 24% from $3,300 to $11,700
- 35% from $11,700 to $16,000
- 37% above $16,000
There is no 12%, 22%, or 32% bracket. The jump from 10% to 24% happens in the low four figures, and a trust earning $50,000 pays the same top marginal rate as an individual earning more than half a million.
Long-Term vs. Short-Term Inside a Trust
Short-term capital gains, from assets held one year or less, are taxed as ordinary income through the brackets above. A trust selling a recently purchased stock for a $20,000 profit pays 37% on the portion over $16,000.4Internal Revenue Service. Topic No. 409, Capital Gains and Losses
Long-term gains, from assets held more than a year, get the same preferential 0%, 15%, and 20% tiers that individuals see, but the thresholds are compressed to match the trust’s ordinary brackets. For 2025, the 0% rate covered only the first $3,250 of trust taxable income, and the 20% rate started above $15,900.1Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1 (2025) – Section: General Instructions The 2026 thresholds are slightly higher after inflation adjustment, but the pattern is unchanged. In practice, the 0% tier is nearly useless for trusts; a single appreciated stock sale almost always lands in the 20% band.
By comparison, a single individual can realize up to $49,450 in long-term gains at the 0% rate in 2026.
The one-year holding period matters more inside a trust than almost anywhere else. Twenty percent on a long-term gain versus 37% on a short-term gain is a 17-point spread on the same dollar of profit.
The 3.8% Surtax on Top
On top of the capital gains rate, most non-grantor trusts owe the Net Investment Income Tax. The NIIT applies to the lesser of the trust’s undistributed net investment income or the excess of the trust’s adjusted gross income over the threshold where the top ordinary bracket begins.5Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax For 2026, that threshold is the same $16,000 that triggers the 37% ordinary bracket.3Internal Revenue Service. Rev. Proc. 2025-32 There is no gap between the two.
Net investment income includes capital gains, interest, dividends, rents, and passive business income. Stacking the surtax on the capital gains rate produces the combined ceilings mentioned at the top:
- Long-term gains: 20% + 3.8% = 23.8%
- Short-term gains and ordinary income: 37% + 3.8% = 40.8%
A single individual doesn’t owe the NIIT until modified adjusted gross income exceeds $200,000; a married couple filing jointly, $250,000.6Internal Revenue Service. Net Investment Income Tax Pushing investment income out to a beneficiary can move the NIIT calculation onto a return where those much higher thresholds apply.
Distributing Gains to Beneficiaries
The distribution deduction is the main lever. When a non-grantor trust distributes income to a beneficiary, it deducts the amount on Form 1041 and the beneficiary reports it on their personal return, keeping the income’s character (qualified dividends stay qualified, long-term gains stay long-term). The ceiling on the deduction is Distributable Net Income (DNI).7Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1 (2025)
Capital gains get harder treatment. Under federal tax law, capital gains allocated to the trust’s principal are excluded from DNI by default, which means the trust can’t deduct them and pays the compressed-bracket rate on the retained gain.8Office of the Law Revision Counsel. 26 U.S. Code 643 – Definitions Applicable to Subparts A, B, C, and D This is the trap: the trust sells an appreciated asset, the gain stays in corpus, and the 23.8% ceiling hits even though the beneficiary might have paid 15% or 0%.
The exclusion has exceptions. Capital gains can be included in DNI if they are paid, credited, or required to be distributed to a beneficiary during the tax year, or if the trust instrument directs that gains be treated as distributable income rather than principal.8Office of the Law Revision Counsel. 26 U.S. Code 643 – Definitions Applicable to Subparts A, B, C, and D State law can also change the default. So before assuming a gain must sit inside the trust, read the trust document. If it authorizes (or requires) capital gains to be treated as distributable, the trustee has room to shift the tax to the beneficiary.
A beneficiary in the 12% ordinary bracket with long-term gains below the 0% capital gains threshold owes nothing on the distributed gain. The trust reports each character of income on Schedule K-1, and the beneficiary picks it up on their own return.
Documentation matters. If the IRS challenges whether a gain was properly distributable, the trustee has to show that the trust instrument or state law authorized it.
The 65-Day Rescue for Year-End Gains
Trustees often don’t know the final tax picture by December 31, especially when a large gain lands late in the year. Section 663(b) lets the trustee treat distributions made within the first 65 days of the new year as if they had been made on the last day of the prior year.9Office of the Law Revision Counsel. 26 USC 663 – Special Rules Applicable to Sections 661 and 662 For a calendar-year trust, that means distributions through March 6 (March 5 in a leap year) can be pulled back into the prior tax year.
The election has to be made on that year’s Form 1041; it doesn’t carry over automatically.10eCFR. 26 CFR 1.663(b)-1 – Distributions in First 65 Days of Taxable Year A trustee who realizes in January that December’s gain was larger than expected can still cut a check in February and pull that income out of the trust’s brackets. Miss the window and the tax gets locked in at trust rates.
Filing Deadlines and Estimated Payments
Form 1041 is due on the 15th day of the fourth month after the trust’s tax year ends. For a calendar-year trust, that’s April 15.11Internal Revenue Service. Forms 1041 and 1041-A: When to File An extension to file is not an extension to pay.
Late filing costs 5% of the unpaid tax per month, up to 25%. If the return is more than 60 days late, the minimum penalty is $525 or 100% of the unpaid tax, whichever is less. A separate failure-to-pay penalty of 0.5% per month runs alongside it, with interest charged on both.12Internal Revenue Service. Failure to File Penalty
Trusts expecting to owe $1,000 or more after credits and withholding generally have to make quarterly estimated payments on Form 1041-ES. A big Q4 capital gain with no estimated payment behind it triggers an underpayment penalty on top of the tax itself, which is the point where trustees who ignored the year’s realized gains until March usually find out what the compressed brackets really cost.