What Is Distributable Net Income?
The term distributable net income (DNI) refers to 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. Therefore, any amount above this DNI figure is tax-free.
- Distributable net income refers to income allocated to the beneficiaries of a trust.
- This figure is the maximum amount received by a unitholder or a beneficiary that is taxable—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 Internal Revenue Service (IRS) considers DNI 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—such as 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 distributable net income or the sum of the trust income required to be distributed—whichever is less—and other amounts “properly paid or credited or required to be distributed” 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.
Estates and trusts are allowed to deduct the distributable net income or the sum of the trust income required to be distributed—whichever is less.
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
An important point to note here is that in instances where there are capital losses, that figure replaces the capital gains and is added to the formula instead.
In order 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.
Example of Distributable Net Income (DNI)
Here's an example of how DNI is calculated using a fictional trust we'll call Trust ABC. Let's say Trust ABC reported total income of $40,000. A total of $10,000 of this was interest income, while the remaining $30,000 was derived from dividends. Fees charged by the trust amounted to $3,000, while the trust realized a capital gain of $15,000. An exemption of $200 applied to the trust.
If we use the formula above, the trust's taxable income is $51,800:
- $51,800 = $10,000 (interest income) + $30,000 (dividends) + $15,000 (capital gain) - $3,000 (fees) - $200 (exemption)
We can then use this taxable income figure to calculate the DNI, which would be $37,000:
- $37,000 = $51,800 (taxable income) - $15,000 (capital gain) + $200 (exemption)