How Are Trusts Taxed in California?

Trust Income Tax Overview

The income tax treatment of a trust depends on whether it is a grantor trust or a non-grantor trust. Grantor trusts (including revocable living trusts) are transparent for income tax purposes — all income is reported on the grantor's personal return. Non-grantor trusts are separate taxpayers that file their own income tax returns (Form 1041) and are subject to their own tax rates. KDA prepares trust tax returns for all types of trusts.

Grantor Trust Taxation

A grantor trust's income is reported on the grantor's personal Form 1040. The trust does not file a separate return (or files a simplified return that shows all income flowing to the grantor's SSN). This treatment applies to revocable living trusts during the grantor's lifetime and to certain irrevocable trusts where the grantor retains specific powers. After the grantor's death (or when the grantor's powers are released), the trust becomes a non-grantor trust and must file its own return.

Non-Grantor Trust Taxation

A non-grantor trust is a separate taxpayer. It files Form 1041 and pays income tax on income it retains (income not distributed to beneficiaries). Income distributed to beneficiaries is deducted by the trust (the distribution deduction) and taxed to the beneficiaries on their personal returns. The trust issues Schedule K-1 to each beneficiary showing their share of trust income.

Compressed Trust Tax Brackets

Non-grantor trusts are subject to severely compressed tax brackets. The top 37% federal rate applies to trust taxable income over approximately $15,200 (2025). For comparison, the top 37% rate for individuals applies to income over $626,350 (single). This means a trust that retains income is taxed at the top rate much faster than an individual. The solution: distribute income to beneficiaries who are in lower tax brackets. KDA advises trustees on the optimal distribution strategy to minimize overall income tax.

Distributions to Beneficiaries

When a trust distributes income to beneficiaries, the trust deducts the distribution and the beneficiary includes it in their taxable income. The character of the income (ordinary income, capital gains, qualified dividends) is preserved — the beneficiary reports the income in the same character as the trust received it. This is reported on Schedule K-1 issued by the trust. KDA prepares Schedule K-1s for all trust beneficiaries as part of the trust tax return preparation.

California Trust Taxation

California taxes trust income if: (1) the trust is a California resident trust (administered in California or created by a California resident), or (2) the trust has California-source income. California's trust tax rates are the same as the individual rates (up to 13.3%). California has a unique rule: if a non-California trust has a California resident beneficiary, California taxes the beneficiary's share of trust income — even if the trust is administered outside California. KDA analyzes the California tax exposure of every trust with California connections.