The term distributable net income (DNI) refers to the income allocated from a trust to its beneficiaries. Distributable net income is the maximum amount received by a unitholder or a beneficiary that is taxable. This figure is capped to ensure there is no instance of double taxation. Any amount above the DNI is, therefore, tax-free.
Key Takeaways
- Distributable net income is income allocated to the beneficiaries of a trust.
- This figure is the maximum taxable amount received by a unitholder or beneficiary—anything above that figure is tax-free.
- DNI gives beneficiaries a reliable income source while minimizing the amount of income taxes paid by the trust.
- DNI is calculated using the trust’s taxable income, subtracting the capital gain or adding the capital loss, then adding the exemption.
Understanding Distributable Net Income (DNI)
The IRS considers distributable net income to be an estimate of the economic value that stems from a distribution to a beneficiary. A distribution is a payment made from a fund—an estate or an income trust—to a beneficiary. DNI gives beneficiaries a reliable income source while minimizing the amount of income taxes paid by the trust.
Just like individuals, estates and non-grantor trusts must file income tax returns. Non-grantor trusts are still funded by the grantor—the person or entity that creates the trust. But this kind of trust functions entirely on its own from the grantor who gives up control of the assets to the trust. The income these trusts report is taxed at either the entity or beneficiary level. Which level is taxed depends on whether it is allocated to the principal amount or to the distributable income, and whether the amount is distributed to the beneficiaries.
According to U.S. tax code, estates and trusts are allowed to deduct the sum of the trust income required to be distributed and other amounts “properly paid or credited or required to be distributed” or the distributable net income, whichever is less, to beneficiaries to prevent double taxation on income. An income trust recognizes distributable net income as an amount transferred to unitholders. With an estate trust, it’s the amount to be distributed to a beneficiary.
Special Considerations
As noted above, when a trust calculates the distributable net income, it essentially prevents any instance of double taxation of the funds issued by a trust. The formula to calculate the figure is as follows:
- Distributable Net Income (DNI) = Taxable Income - Capital Gains + Tax Exemption
In instances where there are capital losses, that figure replaces the capital gains and is added to the formula instead of subtracted. The personal exemption, repealed for individuals through 2025 as part of the Tax Cuts and Jobs Act (TCJA), was not repealed for trusts and estates. Trusts are allowed $100 or $300 exemptions, while estates are allowed a $600 exemption.
To calculate the taxable income, you need to add the interest income, dividends, and capital gains, then subtract any fees and tax exemptions. Unlike the DNI calculation, capital gains are added in the taxable income formula while capital losses are subtracted.
Distributable Net Income (DNI) vs. Net Income
Distributable net income shouldn’t be confused with net income as they are two different things. While DNI is the income distributed from a trust to its beneficiary or beneficiaries, net income is used by a business to calculate its earnings per share (EPS)—the total profit of a company divided by the number of outstanding shares of its common stock—and is also referred to as net earnings.
Net income appears on a company’s balance sheet and helps indicate how profitable the company is. To calculate its net income, corporations subtract any general and administrative expenses, operating expenses, interest, taxes, other expenses, and the cost of goods sold (COGS) from the total amount of sales.
Net income can also refer to an individual’s take-home pay, the amount of money a person receives after any deductions are taken from their paychecks such as taxes, healthcare, disability, insurance, and other expenses. A person’s net income can be contrasted with their gross income—the amount they receive before any deductions.
Example of Distributable Net Income (DNI)
Here’s an example of how DNI is calculated using a fictional trust we’ll call ABC Trust. Let’s say ABC Trust reported total income of $40,000. Interest income was $10,000 of this, while the remaining $30,000 was derived from dividends. Fees charged by the trust amounted to $3,000, and the trust realized a capital gain of $15,000. An exemption of $300 applied to the trust.
If we use the formula above, the trust’s taxable income is $51,700:
- $51,700 = $10,000 (interest income) + $30,000 (dividends) + $15,000 (capital gain) - $3,000 (fees) - $300 (exemption)
We can then use this taxable income figure to calculate the DNI, which would be $37,000:
- $37,000 = $51,700 (taxable income) - $15,000 (capital gain) + $300 (exemption)
Key Questions Answered about DNI
What Is the Difference Between Taxable Income and Distributable Net Income?
A trust’s taxable income includes interest income, dividends, and capital gains, and it subtracts any fees, tax exemptions, and capital losses. For the DNI calculation, capital gains are subtracted back out, while tax exemptions and capital losses are added back in.
Does Distributable Net Income Include Capital Gains?
Distributable net income excludes capital gains and losses. It is removed from the taxable income figure for the purposes of calculating DNI.
What Are the 2022 Trust and Estate Exemption Amounts?
In 2022, a decedent’s estate is allowed a $600 exemption, a trust required to distribute all income is allowed a $300 exemption, and a qualified disability trust is allowed a $4,400 exemption. All other trusts are allowed a $100 exemption.
The Final Word
Distributable net income is the income that is allocated to beneficiaries of a trust, specifically the maximum amount that is taxable. The formula used to calculate DNI takes the taxable income, subtracts capital gains and adds an exemption, which was not eliminated for trusts and estates by the Tax Cuts and Jobs Act.
Related Terms: income, beneficiary, Internal Revenue Service (IRS), distribution, taxable income, double taxation, capital gains, exemption.
References
- Cornell. “26 U.S. Code 661 - Deduction for Estates and Trusts Accumulating Income or Distributing Corpus”.
- Journal of Accountancy. “Trust and Estate Income Tax Returns Under the TCJA.”
- Internal Revenue Service. “2022 Form 1041-ES”, Pages 1 & 2.
