Sometimes. You owe income tax on an irrevocable trust distribution only when it carries the trust's income out to you; a payment of the trust's original principal is not taxed to you.
The pressure behind every distribution comes from Internal Revenue Code section 1(e) and the rate tables in section 1(j). For 2027 a trust pays 37% on taxable income over $16,500, per Rev. Proc. 2026-35; for 2026 (returns filed in 2027) the line is $16,000, per Rev. Proc. 2025-32. The 3.8% net investment income tax can push the rate on kept investment income to 40.8%. So trustees move taxable income out to beneficiaries, who usually pay less.
Millions of trusts and estates file Form 1041 with the Internal Revenue Service (IRS) each year. The rules make sure someone pays tax on the trust's earnings every year: the trust, the beneficiary, or the person who created it.
The Trust Ecosystem: Deconstructing the Key Players and Pieces
An irrevocable trust is a legal arrangement that, once created, generally cannot be changed or canceled by the person who made it. Think of it as a locked box. The creator puts assets in the box, hands the key to a manager, and sets firm rules for who can take things out and when. This structure protects assets and can reduce estate taxes. Even so, most states let an irrevocable trust be changed in limited ways, such as decanting, a nonjudicial modification agreement, or a trust protector's power, so an irrevocable trust can change more often than its name suggests.
The Three Essential Roles: Grantor, Trustee, and Beneficiary
Every trust has three main roles. Knowing who does what is the first step to understanding your own position.
The grantor (also called the settlor or trustor) creates and funds the trust. They write the rulebook and place the first assets inside. With an irrevocable trust, they then give up ownership and control.
The trustee manages the trust. The trustee holds legal title and owes a fiduciary duty to follow the trust's rules solely for the beneficiaries. The job covers investing, record-keeping, tax filings and distributions.
The beneficiary receives money or property from the trust. Current beneficiaries receive income now; remainder beneficiaries receive what is left later. A beneficiary can be a person, a charity, or another trust.
The Trust's Two Money Buckets: Principal vs. Income
Every dollar in a trust sits in one of two buckets.
- Principal (or corpus) is the property that funded the trust: cash, stocks, real estate. Distributions from this bucket are generally tax-free to you.
- Income is what the principal earns: dividends, interest, rent. Distributions from this bucket are generally taxable to you.
The IRS treats the principal as money already taxed, with any gift or estate tax settled when the trust was funded. Taxing it again would be double taxation. The income is new profit nobody has paid tax on yet.
An income beneficiary wants yield; a remainder beneficiary wants growth. State law sorts receipts between the buckets. Many states have replaced the Uniform Principal and Income Act with the Uniform Fiduciary Income and Principal Act, which keeps the trustee's power to adjust and adds a unitrust option that pays a set percentage each year. Check which act your trust's governing-law state uses. The trust document can override these default rules.
The Core Tax Rule: Distributable Net Income
How does the IRS separate taxable income from tax-free principal in a single payment? Through a calculation called distributable net income.
What Distributable Net Income Is and Why It Decides Your Tax
Distributable net income is the most trust income that can be taxed to beneficiaries in a year. Treat it as a ceiling. Distributions up to that amount are taxable income to you. Anything above it is a tax-free distribution of principal.
It does two jobs: it caps the income distribution deduction the trust takes on Form 1041, and it caps the taxable part of your distribution.
A simplified formula under IRC section 643(a): start with the trust's taxable income before the distribution deduction, add back the trust's exemption ($300 simple, $100 complex) and its net tax-exempt interest, then subtract capital gains allocated to principal.
Gains enter distributable net income only when the trust document or state law allocates them to income, when the trustee actually distributes them, or in the trust's final year. Otherwise the trust pays the tax on them.
The income keeps its character on your return. Tax-exempt interest stays tax-exempt to you, and qualified dividends keep their lower rates.
The Big Divide: Grantor vs. Non-Grantor Trusts
The single biggest factor in who pays the tax on trust income is the trust's classification. Is it a grantor trust, where the creator pays, or a non-grantor trust, where the trust or its beneficiaries pay?
Grantor Trusts: When the Creator Pays Your Tax Bill
A grantor trust is one where the grantor kept powers listed in IRC sections 674 through 677, such as the section 675 power to swap assets of equal value. The IRS then ignores the trust for income tax and treats the grantor as owner.
All trust income, deductions and credits land on the grantor's personal Form 1040, and the grantor pays the tax no matter who receives distributions.
A distribution to you from an irrevocable grantor trust carries no income tax, because the grantor already reported every dollar. It is not a new gift either; the gift happened when the trust was funded. Every revocable trust is a grantor trust, and some irrevocable trusts are built this way on purpose (intentionally defective grantor trusts).
Grantor trusts may use optional reporting methods instead of a full Form 1041, so you may never see a Schedule K-1. Ask the trustee.
What Happens to the Taxes When the Grantor Dies?
Many beneficiaries first meet these rules after a parent's death. A trust that becomes irrevocable at death usually turns into a non-grantor trust with its own employer identification number and its own Form 1041, so distributions can start carrying taxable income to you on a Schedule K-1.
Basis is the other question. Assets included in the grantor's taxable estate get a new basis equal to their date-of-death value, so an inherited rental or stock can be sold with little gain. Assets in an irrevocable grantor trust that are excluded from the estate get no basis step-up at death; the IRS confirmed this in Rev. Rul. 2023-2.
For a revocable trust, the trustee and executor can make a section 645 election to treat the trust as part of the estate for income tax purposes during administration.
Non-Grantor Trusts: The "Pass-Through" Tax Model
A non-grantor trust is a separate taxpayer in the eyes of the IRS. It has its own tax ID, an EIN, and files its own annual return, Form 1041.
These trusts work on a pass-through basis.
- If the trust keeps income, the trust pays the tax.
- If the trust distributes income, it takes a deduction, and the beneficiary reports the income and pays the tax.
Non-grantor trusts come in two types:
| Trust Type | Description |
|---|---|
| Simple Trust | Must distribute all income yearly; no principal distributions or charitable gifts. Beneficiaries are taxed on the income even before the cash arrives. |
| Complex Trust | Any trust that is not simple. It can accumulate income, distribute principal and give to charity. |
A simple trust that distributes principal is treated as a complex trust for that year.
The Compressed Tax Bracket Trap: Why Trusts Hate Holding Onto Cash
Trust brackets are compressed. A trust reaches the top rate on a few thousand dollars of taxable income, while a single person does not reach it until $661,375 for 2027. The table below shows both sets of 2027 brackets, with the 2026 trust brackets underneath.
That gap pushes trustees to distribute income rather than keep it, because your return usually taxes it at a lower rate. Distributing is not always better, though: a beneficiary in a high bracket gains little, a child may trigger the kiddie tax, and a beneficiary on SSI or Medicaid can lose benefits.
What the 2025 Tax Law Changed for Trusts and Beneficiaries
The One Big Beautiful Bill Act (Public Law 119-21) made permanent several rules that were due to expire after 2025:
- The compressed trust brackets and the top rate shown in the table above, so the incentive to distribute income stays.
- The higher estate, gift and generation-skipping transfer exemption, indexed for inflation (figures in the generation-skipping section below).
- The end of miscellaneous itemized deductions, which limits what a final-year K-1 can pass to you in Box 11.
- The section 199A qualified business income deduction, which a trust can claim or pass through on your K-1.
| 2027 Federal Income Tax Brackets | Trust | Single Individual |
|---|---|---|
| 10% | $0 to $3,400 | $0 to $12,800 |
| 12% | Not applicable | $12,800 to $52,025 |
| 22% | Not applicable | $52,025 to $109,125 |
| 24% | $3,400 to $12,100 | $109,125 to $208,325 |
| 32% | Not applicable | $208,325 to $264,550 |
| 35% | $12,100 to $16,500 | $264,550 to $661,375 |
| 37% (top rate) | Over $16,500 | Over $661,375 |
For 2026 (returns filed in 2027), the trust brackets are 10% up to $3,300, 24% up to $11,700, 35% up to $16,000, and 37% over $16,000.
The Net Investment Income Tax: Another Reason Trusts Distribute
Under IRC section 1411(a)(2), a non-grantor trust owes the net investment income tax on the lesser of its undistributed net investment income or its adjusted gross income above the dollar amount where the trust's top bracket begins (see the table above). The trust reports it on Form 8960.
When the trust distributes that income, the net investment income moves to you. You owe the tax only if your own modified adjusted gross income is above $200,000 (single) or $250,000 (married filing jointly). Those thresholds are not indexed for inflation.
| 2027 Long-Term Capital Gain and Qualified Dividend Rates | Trust | Single Individual |
|---|---|---|
| 0% | Up to $3,400 | Up to $51,050 |
| 15% | $3,400 to $16,750 | $51,050 to $563,200 |
| 20% | Over $16,750 | Over $563,200 |
Source: Rev. Proc. 2026-35, section 3.03. Gains kept in the trust reach the 20% rate at a fraction of an individual's income.
The Paper Trail: Your Guide to Trust Tax Forms
A small set of IRS forms carries tax information from the trust to you. Knowing them tells you what to expect and when.
The Trust's Master Form: IRS Form 1041
The trustee of a non-grantor trust must file Form 1041, U.S. Income Tax Return for Estates and Trusts, if the trust has $600 or more of gross income, any taxable income at all, or a beneficiary who is a nonresident alien. Form 1041 is the trust's version of your Form 1040.
For a calendar-year trust, Form 1041 and the K-1s are due by the 15th day of the fourth month after year-end. For tax year 2026 that is April 15, 2027, per the Instructions for Form 1041. Form 7004 gives the trust an automatic five-and-a-half-month extension to September 30, 2027, which is the main reason beneficiaries receive K-1s late in the year.
On Form 1041 the trustee reports all income (dividends, interest, rent), subtracts deductible expenses such as trustee and legal fees, and then deducts the income distributed to beneficiaries. The trust pays tax only on what remains.
How to Read Your Schedule K-1 (Form 1041)
Schedule K-1 (Form 1041) is the one tax document every beneficiary of a non-grantor trust needs. The trustee prepares it, sends a copy to you and the IRS, and reports your share of the trust's income, deductions and credits. The trustee must give it to you by the Form 1041 due date, including extensions. Here is what each box means and where it goes on your return:
| Box on K-1 | What It Means | Where It Goes on Your Return |
|---|---|---|
| Box 1: Interest income | Your share of taxable interest. | Form 1040 line 2b (Schedule B Part I if required) |
| Box 2a: Ordinary dividends | Your share of total ordinary dividends. | Form 1040 line 3b |
| Box 2b: Qualified dividends | Part of Box 2a taxed at capital gain rates. | Form 1040 line 3a |
| Box 3: Net short-term capital gain | Gain on assets held one year or less; ordinary rates. | Schedule D |
| Box 4a: Net long-term capital gain | Gain on assets held more than one year; lower rates. | Schedule D |
| Box 5: Other portfolio and nonbusiness income | Royalties, annuities and similar income. | Schedule E or Schedule 1, per the trustee's statement |
| Boxes 6 to 8: Business, rental and other rental income | Your share of trade, rental real estate and other rental income. | Generally Schedule E |
| Box 9: Directly apportioned deductions | Depreciation, depletion or amortization tied to Boxes 5 to 8. | Reported with that activity, per the trustee's statement |
| Box 11 Code A (final year): Section 67(e) excess deductions | Administration costs the trust could not use. | Schedule 1 line 24k |
| Box 11 Code B (final year): Non-miscellaneous itemized deductions | Items such as state taxes paid by the trust. | Schedule A |
| Box 11 Codes C and D (final year): Capital loss carryovers | Short-term (C) and long-term (D) losses passed to you. | Schedule D lines 5 and 12 |
| Box 11 Code E (final year): Net operating loss carryover | The trust's unused NOL. | Schedule 1 line 8a |
| Box 13 Code A: Estimated tax payments | Payments the trust assigned to you on Form 1041-T. | Treated as your estimated tax payment on Form 1040 |
Two cautions. Miscellaneous itemized deductions are not deductible, so some final-year items never make it to your return. And a Box 13 Code A credit is deemed paid on January 15 of the following year for Form 2210 purposes, and it only exists if the trustee filed Form 1041-T on time; it does not go on Schedule 3.
You do not attach the K-1 to your return unless Box 13 Code B shows backup withholding, which you report on Form 1040 line 25c. Keep the K-1 with your records as proof of the income you reported.
A Niche Tool: Form 1041-T
A trust sometimes makes estimated tax payments during the year. Under Internal Revenue Code section 643(g), the trustee can use Form 1041-T, Allocation of Estimated Tax Payments to Beneficiaries, to hand credit for those payments to the beneficiaries. The amount then shows in Box 13 of your K-1 with code A, and you claim it as a tax payment on your own return.
Timing is strict. The trustee must file Form 1041-T by the 65th day after the trust's year ends, or the election fails and you get no credit. IRS.gov posts Form 1041-T (2026) for 2026 tax years.
Real-World Scenarios: Putting It All Together
Four common distribution scenarios show how these rules work in practice.
Scenario 1: The Simple Income Payout
Maria is the sole beneficiary of a non-grantor trust. This year the trust earned $15,000 in dividends and paid $1,000 in trustee fees. The trustee distributes all the net income to her. Her K-1 will show the $14,000 as dividends, mostly qualified dividends if the trust's were qualified, not as generic "income," so she keeps the lower rate.
2026 tax year figures:
| Action | Consequence |
|---|---|
| Trust computes distributable net income: $15,000 dividends minus $1,000 fees = $14,000. | $14,000 is the most that can be taxed to Maria. |
| Trustee pays Maria $14,000. | Maria receives the cash. |
| Trust files Form 1041 and deducts the $14,000 distribution. Taxable income is $0. | The trust pays no federal income tax. |
| Trustee issues Maria a K-1 showing $14,000 in Box 2a (qualified portion in Box 2b). | Maria reports the dividends on her own return at her rates. |
Scenario 2: The Big Purchase Payout
David is the beneficiary of a complex trust. This year the trust's DNI is $20,000. To help him buy a car, the trustee makes a discretionary distribution of $35,000.
2026 tax year figures:
| Action | Consequence |
|---|---|
| Trust's distributable net income is $20,000. | That is the ceiling for taxable income. |
| Trustee pays David $35,000. | David receives the full amount. |
| Distribution splits into two parts. | $20,000 is taxable income; $15,000 is tax-free principal. |
| Trustee issues David a K-1 for $20,000. | David reports $20,000. The $15,000 is not reported. |
Distributions Made in January to March: The 65-Day Rule
Suppose David's $35,000 check arrives in February 2027. Which year's K-1 does it belong on? Under Internal Revenue Code section 663(b), the trustee of a complex trust can elect to treat distributions made in the first 65 days of a year as if they were made on the last day of the prior year. The election is made on that prior year's Form 1041.
So a check you receive in February 2027 may show up on your 2026 K-1, not your 2027 one. This is a leading cause of "my K-1 doesn't match what I got this year" confusion. If you receive a distribution in January, February or early March, ask the trustee which tax year it belongs to before you file.
Scenario 3: The Stock Transfer ("In-Kind" Distribution)
Sarah is the beneficiary of a trust that owns 100 shares of ABC Corp. The trust's original cost (its basis) was $10,000. The stock is now worth $50,000. The trustee gives Sarah the shares instead of cash. The trust has at least $50,000 of DNI.
2026 tax year figures:
| Action | Consequence |
|---|---|
| Trustee distributes 100 ABC Corp. shares to Sarah in kind. | Sarah owns the stock directly. |
| Default rule under IRC section 643(e): the trust does not recognize the $40,000 gain. | The trust pays no capital gains tax on the transfer. |
| Distribution amount is the lesser of basis or value: $10,000. Sarah takes the trust's $10,000 carryover basis. | Sarah's K-1 shows $10,000 of income. Tax on the $40,000 is deferred. |
| Sarah sells a month later for $50,000. Her holding period includes the trust's. | She reports a $40,000 long-term capital gain. |
If the trustee makes the section 643(e)(3) election, the trust recognizes the $40,000 gain, the distribution counts at its $50,000 fair market value, and Sarah's basis is $50,000 fair market value. This is not a death step-up. The election applies to every in-kind distribution the trust makes that year.
Special Circumstances and Advanced Topics
A beneficiary's age, health and home state can all change the basic rules.
Distributions to Minors: The "Kiddie Tax" Explained
When a trust makes a taxable distribution to a child, the kiddie tax may apply. It stops parents from shifting investment income to children in lower brackets.
It applies to a child under 18 at year end, to an 18-year-old whose earned income is not over half their support, and to a full-time student aged 19 to 23 under the same support test. Taxable trust distributions on a K-1 count as unearned income and are reported on Form 8615.
Here is how it works for 2027 (2026 figures in parentheses), per Rev. Proc. 2026-35 and Rev. Proc. 2025-32. Unearned income over $2,800 for 2027 ($2,700 for 2026) is taxed at the parents' rate.
| Child's Unearned Income | 2027 Amount | 2026 Amount | How It Is Taxed |
|---|---|---|---|
| First tier | $1,400 | $1,350 | Not taxed (covered by the child's standard deduction) |
| Second tier | Next $1,400 | Next $1,350 | Taxed at the child's own rate, usually 10% |
| Above the two tiers | Over $2,800 | Over $2,700 | Taxed at the parents' marginal rate |
Beneficiaries with Disabilities: Special Needs Trusts and ABLE Accounts
A beneficiary who relies on Supplemental Security Income (SSI) or Medicaid can lose those benefits from a direct inheritance. Two tools prevent that.
A third-party special needs trust is funded by someone else and owes nothing to Medicaid at death. A first-party trust holds the beneficiary's own money and must repay Medicaid. A qualifying special needs trust can be taxed as a qualified disability trust, which gets a larger exemption than other trusts.
Since September 30, 2024, the Social Security Administration no longer counts food as in-kind support, so a trustee paying for groceries does not reduce SSI. Paying for shelter still can.
2026 limits:
| Tool | Description |
|---|---|
| Special Needs Trust | Holds assets for the beneficiary. Direct cash usually counts as SSI income, so trustees pay vendors for therapy, travel and education. |
| ABLE Account | Tax-free growth for disability expenses, including housing. 2026 limit $20,000; disability onset before age 46; 529-to-ABLE rollovers permanent. |
Employed beneficiaries can add "ABLE to Work" contributions above the $20,000 limit, now permanent, per the IRS ABLE page. The IRS will publish the 2027 limit.
The Multi-State Maze: State Income Taxes
A trust can owe tax in more than one state based on where the grantor lived, where the trustee sits and where beneficiaries live. California, for example, taxes a non-grantor trust's accumulated income in proportion to its California-resident fiduciaries and non-contingent beneficiaries, and income held for a contingent California beneficiary can be taxed when it is later distributed. California and New York also treat incomplete-gift non-grantor trusts as grantor trusts.
You generally report K-1 income on your own return in your home state, while the trust may file where the trustee lives or where it earns income. A trustee in Texas running California rentals still files a California trust return.
The Generation-Skipping Transfer Tax
The generation-skipping transfer tax is a flat 40% federal tax on transfers to skip persons, such as grandchildren, on top of any estate or gift tax. Each person has an exemption of $15,480,000 for 2027 and $15,000,000 for 2026, per Rev. Proc. 2026-35 and Rev. Proc. 2025-32 (the 2025 figure was $13,990,000).
If the trust's inclusion ratio is zero, no tax applies. Otherwise, on a taxable distribution to you as a skip person, you owe the tax and report it on Form 706-GS(D) using the trustee's Form 706-GS(D-1). On a taxable termination, the trust pays on Form 706-GS(T).
Common Mistakes, Rights, and How to Protect Yourself
Being a beneficiary can be confusing, and mistakes cost real money. Knowing the common pitfalls and your rights is your best defense.
Mistakes to Avoid as a Beneficiary
- Assuming all distributions are tax-free. Treat every distribution as taxable until the K-1 proves otherwise.
- Ignoring your Schedule K-1. The IRS gets a copy, so the income on it must appear on your return.
- Not talking to the trustee. The trustee is your main source of information; silence leads to delays and surprises.
- Being a passive recipient. You have a right to be kept reasonably informed, and to ask questions when something feels wrong.
- Filing before the K-1 arrives. Guessing leads to amended returns. If the trust filed for an extension, extend your own return too.
- Forgetting that K-1 income raises your AGI. That can increase Medicare IRMAA premiums, cut Affordable Care Act credits and make more of your Social Security taxable.
- Misreporting the basis of in-kind assets. Use the trust's carryover basis unless the trustee tells you a section 643(e)(3) election was made.
Your Rights as a Trust Beneficiary
State laws vary, but you have basic rights that let you oversee the trust and protect your inheritance. Many states base these rights on section 813 of the Uniform Trust Code, which requires the trustee to keep qualified beneficiaries reasonably informed.
| Beneficiary Right | Why It Matters |
|---|---|
| Right to information | You must be kept reasonably informed about the trust, including a copy of the trust document and regular financial accountings. |
| Right to timely distributions | The trustee must follow the schedule and terms in the trust document and cannot withhold mandatory payments without a valid reason. |
| Right to an accounting | You can demand a detailed report of all income, expenses and distributions, usually yearly. It is your main tool for spotting mismanagement. |
| Right to hold the trustee accountable | If a trustee mismanages assets, plays favorites or ignores duties, you can ask a court to compel action or remove the trustee. |
What to Do if You Disagree with Your K-1 or the Trustee
Disputes with a trustee are stressful, but there is a clear path for working through them.
| Do's | Don'ts |
|---|---|
| Do write first. State the concern plainly and ask for the trust's financial statements. | Don't make accusations or threats; hostility rarely helps and is not grounds for action alone. |
| Do request a corrected K-1 if the figures are wrong. | Don't ignore the K-1. Reporting differently requires Form 8082, Notice of Inconsistent Treatment. |
| Do ask why a discretionary decision was made. | Don't demand discretionary distributions; the trustee decides within the trust's terms. |
| Do try mediation if letters fail. | Don't sue over minor issues; litigation drains trust assets. |
| Do consult a trust attorney before formal action. | Don't handle a serious dispute alone; a bad-faith claim against you is costly. |
What to do next
- Ask the trustee whether the trust is a grantor or non-grantor trust.
- Watch for your Schedule K-1; if it is late, file Form 4868 rather than guess.
- Match each K-1 box to the lines in the table above.
- Check how your state taxes trust income before filing.
Frequently Asked Questions (FAQs)
My K-1 shows taxable income, but I didn't receive any cash. Do I still owe tax?
Yes. In a simple trust you are taxed on your share of the year's income whether or not the cash has arrived. The same can happen in a complex trust with mandatory income distributions.
My parent created the trust and pays all the taxes. Is this normal?
Yes. That makes it a grantor trust. The IRS treats your parent as owner of the assets, so your parent pays the income tax and distributions to you are not income.
Can I refuse a distribution from a trust?
Usually. A qualified disclaimer under IRC section 2518 must be in writing, delivered within 9 months of the transfer (or of turning 21), and made before you accept any benefit. Talk to an attorney first.
What happens if the trust sells a house and gives me the cash?
Gains usually stay in the trust and are taxed there, and the cash reaches you as tax-free principal. Gains can be carried out to you when the trust document or state law allocates them to income, or in the trust's final year. They then appear in Box 3 or 4a of your K-1.
Can a trustee stop my distributions if they don't like me?
No. A trustee cannot withhold mandatory distributions out of dislike. Discretionary distributions still require good faith. Hostility that impairs administration can be grounds for removal.
Does an irrevocable trust have to file a tax return every year?
Yes, when it has $600 or more of gross income, any taxable income, or a nonresident alien beneficiary. Grantor trusts are the exception; the grantor reports the income personally.
What is a "trust protector"?
An independent third party given special powers, such as removing a trustee or amending the trust for new laws, to add flexibility and oversight.
Related reading
- Are Family Trust Distributions Taxable? + FAQs
- Does a Beneficiary Pay Taxes on a Irrevocable Trust? (w/Examples) + FAQs
- How Do Trust Funds Pay Out? (w/Examples) + FAQs
- Can an Irrevocable Trust Pay for the Grantor’s Expenses? (w/Examples) + FAQs
- How Is a Grantor Trust Taxed Differently? (w/Examples) + FAQs
- Can a Grantor Be a Beneficiary of an Revocable Trust? + FAQs
Will I get a Form 1099 for my trust distribution?
No. Taxable trust distributions are reported to you on Schedule K-1 (Form 1041), not on a 1099. The trust itself receives the 1099s for its investments. If you got only a check and no K-1, ask the trustee whether the trust is a grantor trust or whether the payment was a distribution of principal.
When should I receive my K-1, and what if it's late?
K-1s are due with the trust's Form 1041: April 15, 2027 for a calendar-year 2026 trust, or as late as September 30, 2027 if the trustee filed Form 7004. If yours is late, file Form 4868 to extend your own return instead of guessing the numbers and amending later.
Do I pay tax on what I inherit from an irrevocable trust after the grantor dies?
Principal you receive is not income. You pay income tax only on the distributable net income shown on your K-1. There is no federal inheritance tax; any estate tax is paid by the estate, and only above the federal exclusion described above. A few states impose inheritance tax. Your basis depends on whether the assets were in the grantor's estate.