What is Distributable Net Income (DNI)?

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Distributable Net Income is a tax law term that has a specific application in the taxation of estates and trusts and their beneficiaries. Trusts get tax deductions for the amount of distributions made but this is limited to the DNI.

To recap, trust or estate income is taxed to either the entity or the beneficiary. If income is accumulated and not deemed distributed, it is taxed to the trust or estate. If income is distributed, the trust gets deduction for amount of distribution, but not more than the Distributable Net Income (DNI). The beneficiary accounts for income distributed on his own tax return, again limited to DNI as a ceiling.

Prior to 1954, the income tax treatment of distributions depended on whether the amounts in question were treated as coming from principal or from fiduciary income, requiring complicated tracing under local law. A uniform federal standard in the form of Distributable Net Income was then created. DNI adjustments are several, as the illustration shows, but the ides is to break out the sums that are properly reportable by the beneficiaries and which can be deducted by the entity.

Distributable Net Income (DNI) = Taxable Income – Capital Gain (+ Capital Loss) + Tax Exemption
Where: Taxable Income = Interest Income + Capital Gain (-Capital Loss) + Dividends – Tax Exemption – Fees

For a simple worked example and more information see Distributable Net Income (DNI), for more depth Demystifying Distributable Net Income – Income Taxation of Estates and Trusts 55th Annual Heckerling Institute on Estate Planning.

What is a ratable (proportional) share of DNI?

If the trustee is not required to distribute any income currently but has discretion to pay income or corpus or both to the beneficiaries, DNI simplifies matters because discretionary distributions do not need to be traced to fiduciary accounting income or corpus. Instead, all distributions burden the beneficiaries with a pro rats share of Distributable Net Income.

Example: Assume the trustee pays $100 of fiduciary accounting income to Adam, and $500 of corpus to Eve. The remaining fiduciary accounting income is accumulated in the trust, for total distributions of $600. Assume that DNI has been determined by the above formula as $300, in other words, the trust is allowed a distribution deduction of $300. On a pro rate basis Adam will be taxed on $250 ($300 * 500/600) and Eve on $50 ($300 * 100/600). The remaining amounts paid to them (total distributions were $600) are treated as tax-free distributions of corpus.

Adapted from: McCouch, Grayson M. P. 2020. Federal income taxation of estates, trusts, and beneficiaries.

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