For tax purposes a Simple Trust requires that all income generated by the trust be distributed each year to the trust’s beneficiaries. Even if a trust distributes all its income every year this alone does not necessarily make it a simple trust though. Understanding the trust document is important. If all income is not distributed the trust is essentially a complex trust, any net income after expenses is taxed in the trust at the trust’s tax rate. If distributed, the beneficiaries’ share of taxable income after expenses is reported on a K-1 and taxed on the beneficiaries respective returns at their respective tax rates.
A trust treated as a simple trust in year 1 can become a complex trust in future years if it doesn’t violate the trust agreement. I’ve seen this happen when the trust wishes to make charitable donations. A Simple Trust is prohibited from allowing its funds to be used for charitable purposes.
If the income is not distributed out of a simple trust annually, the Trustee has problems. That is where tax problems happen and I get called in. What I have learned is that ultimately the beneficiary may be taxed on the income whether it is distributed or not particularly when a simple trust becomes a complex trust without the beneficiaries grasping the tax realities of the change.