Trust funds are taxed differently, depending on the type of fund they are.
A trust that distributes all its income is considered to be a simple trust; otherwise the trust is said to be complex. A tax deduction is made for income that is distributed to beneficiaries. In this case, the beneficiary pays the income tax on the taxable amount, rather than the trust.
The amount distributed to the beneficiary is considered to be from the current-year income first, then from the accumulated principal. This is usually the original contribution plus subsequent ones and is income in excess of the amount distributed. Capital gains from this amount may be taxable to either the trust or the beneficiary. All the amount distributed to and for the benefit of the beneficiary are taxable to him or her to the extent of the distribution deduction of the trust.
If the income or deduction is part of change in the principal or part of the estate‘s distributable income, then income tax is paid by the trust and not passed on to the beneficiary. An irrevocable trust that has discretion in distribution of amounts and retains earnings pays trust tax that is 35% of annual income over $12,700. The K-1 schedule for taxing distributed amounts is generated by the trust and handed over to the IRS. The IRS, in turn, delivers the document to the beneficiary to pay the tax. The trust then completes Form 1041 to determine the income distribution deduction that is accorded on the distributed amount.