Can Distributable Net Income (DNI) Exceed Taxable Income?

Posted Jan 24, 2023


Distributable net income (DNI) is a tax deduction allowed by trusts. DNI must be calculated to determine its value. Part of the DNI calculation includes taxable income. If taxable income is part of the DNI calculation, does that mean taxable income is always equal to or less than DNI?

DNI and Taxation

Trusts that earn an income must pay taxes unless the income is distributed. When income is distributed from a trust, the trust earns a deduction. The value of DNI caps the deduction. However, it isn't always necessary to distribute income to earn the DNI deduction. This can depend on the type of trust (i.i., simple vs. complex).

A trust can distribute more than the DNI amount. Distributing beyond DNI results in distributing principal from assets. Taxes have already been paid on the principal. Any principal distributions do not incur taxes by the trust or beneficiary.

Does DNI Ever Exceed Taxable Income?

To figure this out, let's look at the DNI calculation. The first step is to calculate taxable income for the trust:

Taxable Income = Interest Income + [+Capital Gain or -Capital Loss] + Dividends - Tax Exemption - Fees

Add taxable income to the DNI formula:

Distributable Net Income (DNI) = Taxable Income + [-Capital Gain or + Capital Loss] + Tax Exemption

Using the above, if there are no capital gains or losses or tax-exempt income, then DNI will equal taxable income (before deduction). At least we know DNI and taxable income can be equal. But what about DNI exceeding taxable income?

To answer that question, let's first look at the above formulas, where we can see some limitations with DNI exceeding taxable income. Note that the DNI formula uses the opposite values for the following:

  • Capital gain/loss
  • Tax exemption

The above entries aren't a factor when trying to answer this question since they simply cancel each other out. The following example shows this:

Taxable Income = $0 + $20,000 + $0 - $500 - $0 = $19,500

DNI = $19,500 - $20,000 + $500 = $0

If we eliminate the above variables, here's what we're left with:

Taxable Income = Interest Income + Dividends - Tax Exemption - Fees

And now DNI becomes:

DNI = Taxable Income

As you can see, at best, DNI will equal taxable income but not exceed it, as it is mathematically impossible.

Keep in mind that the amount distributed from the trust can be greater or less than DNI. If it is greater than DNI, the excess amount is considered a distribution of principal and generally not taxed at the trust or beneficiary level. If the distribution is less than DNI, then the trust has retained some of its income.

Calculating DNI can be a complex process. It's best to work with an estate and tax attorney when trying to calculate the taxable income and DNI of a trust.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.

Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

Hypothetical examples shown are for illustrative purposes only.

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