Matching Taxes to Their Source
Trust taxation is not a single line item. Different receipts within the same trust can be classified differently for accounting purposes. Some go to income (interest, dividends, rent). Others go to principal (capital gains from asset sales). This statute creates a straightforward rule: the tax follows the receipt. Whatever generated the tax liability is the fund that pays it.
A tax required to be paid by a trustee based on receipts allocated to income must be paid from income.
A.R.S. § 14-7429(A)This principle keeps the trust fair. Income beneficiaries bear the tax cost of income they receive, and remainder beneficiaries bear the tax cost of gains that build principal. Neither side subsidizes the other.
Entity Income and Mixed Allocations
Trusts often hold interests in entities like partnerships or S corporations. Those entities produce taxable income that may be allocated partly to income and partly to principal. Arizona law handles the split proportionally: the trust pays the tax from each fund in the same ratio that receipts were allocated to each fund. If the tax exceeds the total receipts from the entity, the excess comes from principal.
A tax required to be paid by a trustee on the trust's share of an entity's taxable income must be paid proportionately from principal and income to the extent that receipts from the entity are allocated to both income and principal.
A.R.S. § 14-7429(C)(3)The statute also requires one more adjustment. After the initial allocation, the trustee must account for any tax deduction the trust receives because of distributions to beneficiaries. If a distribution lowers the trust's overall tax bill, the trustee adjusts income or principal receipts to reflect that benefit.
