What is Distributable Net Income (DNI) and How Do You Calculate It?

Most trusts eventually distribute their assets to beneficiaries. Whether taxes are owed on those distributions depends on a number of factors. Distributable net income is one of those factors. It can also help in reducing a trust’s tax bill.

Simple Vs. Complex Trust

A simple trust doesn’t pay out income while the grantor is alive. Once the grantor passes, income is paid out to beneficiaries. On the other hand, complex trusts can retain income rather than distribute it.

Does the beneficiary have to pay taxes on a trust’s distributions? This depends if the trust has paid taxes on the income or not. If not, then the beneficiary may owe taxes on the distribution. In that case, the trust has offloaded the tax responsibility to the beneficiary. Additionally, the trust will receive a deduction on the income. The deduction is there to prevent paying income taxes twice.

If principal is distributed, no taxes are owed since taxes were paid when the assets went into the trust. Principal is made up of all the assets placed into the trust at their cost basis when added. At the federal level, principal is not taxed, but some states may impose an inheritance tax on beneficiaries.

A trust can distribute income above the distributable net income (DNI), but this additional income will be principal, which isn’t taxed.

Trust Accounting

Trust accounting ensures that income and expenses are correctly accounted for. This means categorizing and pairing income and expenses. 

For example, a rental property within a trust will have income and expenses. Trust accounting will keep the rental property’s income and expenses grouped. This is in contrast to listing all income and expenses from every source on an income statement with no grouping, making it difficult to determine which expenses offset which income.

Trust administration expenses such as auditing, legal, trustee fees, and insurance must be properly labeled and kept separate from business-related expenses (i.e., rental property). Unlike business expenses, trust administration expenses are not incurred from generating income.

Trust accounting income (TAI) is a specific type of income available to the trust’s beneficiaries. TAI is the income net of expenses incurred due to the trust-generating income. TAI might be calculated differently depending on the state. Most states have adopted a specific method for calculating trust income called the Uniform Principal and Income Act (UPIA).

Distributable Net Income (DNI)

DNI is calculated to determine the amount of tax deduction a trust can take. This deduction can be taken whether DNI is distributed or not. DNI is the maximum taxable amount that can be distributed to beneficiaries.

To calculate DNI, first, calculate taxable income for the trust:

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

Plug taxable income into the DNI formula:

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

To see this in practice, let’s go through an example.

Trust income: $50,000

Dividends: $25,000

Interest Income $25,000

Capital gains: $40,000

Administration fee: $7,500

Tax exemption: $250

Taxable income = $25,000 + $40,000 + $25,000 - $250 - $7,500 = $82,250

Next, calculate DNI:

$82,250 - $40,000 + $250 = $42,500

DNI minimizes a trust’s tax bill through the DNI deduction. Not all trusts will have income. Distributions from non-income trusts are from principal and not taxed at the trust level. The beneficiary may still pay taxes on principal distributions. Working with an estate and tax attorney is best when determining DNI and whether any taxes are owed on distributions.