How Trusts and Estates Are Taxed After OBBBA: The 2/37 Rule, the AMT, and the 65-Day Window

Non-grantor trusts and estates face the most compressed tax schedule in the code, and 2026 makes it more consequential. A trust reaches the 37% bracket and the 3.8% net investment income tax at just $16,000 of income, and the 20% capital gains rate at $16,250. The One Big Beautiful Bill Act added a new layer: the 2/37 limitation on itemized deductions now applies to trusts and estates, which were previously exempt from the old Pease limit. How far that cut reaches inside a trust is the most consequential open question in fiduciary tax right now. Congress's Joint Committee on Taxation reads it as reaching the deduction trusts take for income they distribute to beneficiaries, practitioner groups are contesting that reading, and the IRS has issued no guidance. Trustees should plan around the cautious reading, preserve flexibility, and treat the 65-day distribution window that closes in early March 2027 as a real decision point.

Why does trust taxation matter so much?

Because a non-grantor trust is its own taxpayer, and its brackets are a fraction of an individual's. A married couple does not reach the 37% bracket until $768,700 of taxable income in 2026; a trust reaches it at $16,000. Income a trust accumulates is taxed at the top rate almost immediately, while income it distributes is generally taxed to the beneficiaries at their own, usually lower, rates.

That gap is why distribution policy is the central tax lever in trust administration. A trustee balancing what the trust document permits, what the beneficiaries need, and what the family's long-term goals require is also, whether intentionally or not, deciding who pays the tax and at what rate.

Grantor trusts are different. Their income is taxed to the grantor under Section 671, so the trust-level brackets and the trust-level 2/37 analysis do not apply; the grantor's own return, with individual thresholds, governs. Most revocable living trusts and many irrevocable planning trusts, such as intentionally defective grantor trusts, fall in this category, as described in revocable vs. irrevocable trusts.

What are the 2026 rates and thresholds for trusts?

Long-term capital gains and qualified dividends are taxed at 0% up to $3,300, 15% up to $16,250, and 20% above that. The 3.8% net investment income tax applies to the lesser of undistributed net investment income or adjusted gross income above $16,000. All figures are from IRS Revenue Procedure 2025-32 and the draft 2026 Form 8960 instructions.

How does the 2/37 rule apply to trusts?

The new Section 68 reduces itemized deductions by 2/37 of the lesser of those deductions or income above the start of the 37% bracket. The general mechanics are explained in the 2/37 rule. For trusts, two features make it far more significant than for individuals.

First, the threshold is $16,000, so almost every taxable trust is above it. Second, the question of what counts as an itemized deduction for a trust is unsettled. Trusts compute taxable income the same way individuals do, with specific exceptions, under Section 641(b), and the old Section 68(e) exemption for trusts and estates was repealed. That much is settled: the rule applies to non-grantor trusts and estates beginning in 2026.

What it reaches is not settled. In its May 2026 general explanation of the law, the Joint Committee on Taxation stated in a footnote that a trust's personal exemption and its income distribution deduction are itemized deductions for this purpose. If that reading holds, a trust that distributes all of its income still owes some tax, because 2/37 of the distribution deduction is disallowed at the trust level, while the beneficiaries are still taxed on the full distribution. The AICPA, the American College of Trust and Estate Counsel, and the New York State Bar Association have all asked Treasury or Congress for relief, and the AICPA has asked the IRS to waive 2026 estimated tax penalties for trusts and estates given the absence of guidance.

The Joint Committee's explanation is persuasive but not binding, and guidance could narrow it. A trustee who plans around the cautious reading and is later proven too conservative has lost little. A trustee who assumes the generous reading and is wrong may face underpaid estimated taxes and an uncomfortable conversation with beneficiaries.

Does the new charitable floor apply to trusts?

Generally no. The new floor that disallows charitable gifts up to 0.5% of income appears in Section 170, in the rules for individuals. Most trusts deduct charitable payments under Section 642(c) instead, which has no floor, and practitioner commentary agrees it does not apply. Two exceptions: the S corporation portion of an electing small business trust and any grantor trust deduct charity through Section 170, so the floor can reach them. Whether the 2/37 cut itself reaches the Section 642(c) deduction is the open question noted above.

What about the alternative minimum tax?

Trusts and estates have their own AMT exemption, which is $31,400 for 2026. It begins phasing out at $104,800 of alternative minimum taxable income and, under the new law's faster 50% phase-out rate, is fully gone at $167,600. Before the change, the same exemption would have survived to $230,400. Trusts kept their inflation-adjusted starting point but received the faster phase-out that applies to individuals.

AMT exposure for trusts and estates usually arises from large state tax deductions, which the AMT disallows, from private activity bond interest, or from an estate exercising a decedent's incentive stock options. The individual rules, which work similarly, are covered in the alternative minimum tax explained.

What is the 65-day window, and why does it matter now?

Section 663(b) lets the trustee of a complex trust or an estate elect to treat distributions made in the first 65 days of a year as if they were made on December 31 of the prior year. The elected amount is capped at the greater of the trust's accounting income or its distributable net income for the year, less amounts already distributed. The election is made on the timely filed Form 1041, including extensions, and is irrevocable once that deadline passes.

For 2026 distributions, the 65th day of 2027 is March 6, which falls on a Saturday. We have found no authority confirming the deadline rolls to Monday, so the prudent practice is to complete any distributions by Friday, March 5, 2027.

The window matters more this year for two reasons. Trusts reach the top rates at $16,000, so distributing income to beneficiaries in lower brackets saves real tax. And under the Joint Committee's reading of the 2/37 rule, even full distribution leaves a trust-level residue, which makes it more valuable to size distributions after the year's actual numbers are known rather than estimating them in December. For trusts and estates required to make estimated payments, the fourth-quarter installment is due January 15, 2027, before the 65-day window closes, which is another reason to model the year early. Estates, and certain trusts receiving a will's residue, are exempt from estimated tax for their first two years.

The 65-day election is a tax tool, not a substitute for the trust document. A distribution must still be permitted by the governing instrument and consistent with the trustee's fiduciary duties to all beneficiaries, a point that matters when choosing who serves as trustee, as discussed in corporate trustee or family member.

Are there other 2026 changes trustees should know?

A few. A non-grantor trust has its own state and local tax deduction cap of $40,400 for 2026, subject to the same phase-down for higher incomes, and those deductions are then subject to the 2/37 cut. Creating multiple trusts primarily to multiply the cap runs into the anti-abuse rule of Section 643(f), which can treat substantially similar trusts as one. Non-grantor trusts may also each hold their own qualified small business stock exclusion, a planning technique that requires care and is covered in QSBS after the One Big Beautiful Bill. And the $15,000,000 estate and gift exemption, now permanent, continues to shape which trusts are worth creating in the first place, as discussed in the trusts wealthy families actually use.

A worked example: a trust that distributes everything

The following is a hypothetical illustration using 2026 rates, ignoring the trust's small personal exemption, state tax, and the net investment income tax.

A complex trust earns $1,000,000 of ordinary income and distributes all of it to its beneficiaries. Under prior law, the distribution deduction would have offset the income entirely, the trust would have owed nothing, and the beneficiaries would have been taxed on $1,000,000.

Under the Joint Committee's reading, the distribution deduction is an itemized deduction subject to the 2/37 rule. The trust's income before that deduction exceeds the $16,000 threshold by $984,000, which is less than the $1,000,000 deduction, so the cut is 2/37 of $984,000, or $53,189. That amount becomes trust taxable income, producing about $17,611 of federal tax at trust rates, while the beneficiaries are still taxed on the full $1,000,000 they received. Practitioners have characterized this as a partial double tax, and it is one of the main reasons relief has been requested.

If guidance excludes the distribution deduction from Section 68, the trust's liability in this example falls back to zero. Until then, the cautious course is to budget for the cut in estimated payments and revisit once the IRS speaks.

Key numbers at a glance

Frequently asked questions

Does the 2/37 rule apply to trusts?Yes. The new law repealed the provision that exempted trusts and estates from the old itemized deduction limitation, so non-grantor trusts and estates are subject to the 2/37 rule beginning in 2026, with a threshold of just $16,000.

Does the 2/37 rule reduce a trust's distribution deduction?That is unsettled. The Joint Committee on Taxation says it does, which would leave some trust-level tax even when all income is distributed. Several professional organizations have asked for relief, and the IRS has not issued guidance. Planning around the cautious reading is prudent until it does.

Does the 0.5% charitable floor apply to trusts?Generally not, because most trusts deduct charitable payments under Section 642(c), which has no floor. The S corporation portion of an electing small business trust deducts through Section 170 and can be affected, and a grantor trust's gifts are deducted on the grantor's own return, where the floor applies. Whether the 2/37 cut reaches the Section 642(c) deduction is still an open question.

What is the 2026 AMT exemption for trusts?$31,400, phasing out between $104,800 and $167,600 of alternative minimum taxable income at the new 50% rate.

When is the 65-day deadline for 2026 trust distributions?March 6, 2027, which falls on a Saturday. Completing distributions by Friday, March 5 is the prudent approach, and the election must be made on the trust's timely filed 2026 return.

Are grantor trusts affected by these rules?Not at the trust level. A grantor trust's income is taxed to the grantor, so the grantor's own return and individual thresholds apply, including the individual version of the 2/37 rule.

Sources

• Rev. Proc. 2025-32: Inflation adjustments for tax year 2026, Internal Revenue Service
• 26 U.S. Code § 68: Overall limitation on itemized deductions, Legal Information Institute, Cornell Law School
• 26 U.S. Code § 55: Alternative minimum tax imposed, Legal Information Institute, Cornell Law School
• 26 CFR 1.663(b)-1: Distributions in first 65 days of taxable year, Legal Information Institute, Cornell Law School
• Draft 2026 Instructions for Form 8960, Net Investment Income Tax, Internal Revenue Service
• Higher taxes for trusts and estates under the One Big Beautiful Bill Act, Journal of Financial Planning, October 2026
• The 2/37 haircut on distributable net income: what fiduciaries need to know, Withum, August 2026
• CPAs say IRS should waive 2026 trust and estate estimated tax penalties, Thomson Reuters, November 2026
• Comments to Treasury and the IRS on the One Big Beautiful Bill Act, American College of Trust and Estate Counsel, November 10, 2025