Succession Planning: New Tax Law Limit Hits Small Trusts

THE PROVISION THAT HAS NOT MADE THE HEADLINES

The One Big Beautiful Bill imposed a new limitation on itemized deductions for top earners. The rule reduces what high-income taxpayers can deduct once their income exceeds the 37 percent tax bracket. The technical formula is complex (reduced by 2/37 of the lesser of the total itemized deductions or the amount of taxable income exceeding the top 37 percent rate threshold).

What most advisors and their clients missed is that this limitation now applies to trusts and estates as well as individuals.

That matters because trusts are taxed differently from individuals. A trust reaches the top income tax bracket at income levels far lower than any individual filer. In 2026, the threshold that triggers the 37 percent rate for a trust is approximately $16,000 in taxable income. For a single individual, that same rate does not apply until income exceeds $640,600.

The result is that a trust with $16,000 in annual income is now subject to the same deduction limitation designed for the highest-earning individuals in the country. Tax experts have described this as a double taxation problem: assets contributed to the trust may already have been taxed when transferred, and the income generated inside the trust now faces an additional layer of limitation on top of that.

The bottom line: A provision most people are not discussing applies a new deduction limitation to trusts at income levels as low as $16,000 per year. Business owners with trusts in their succession structure need to understand how this applies to each one specifically.

WHAT THIS MEANS FOR BUSINESS SUCCESSION PLANS

Business owners use trusts in succession structures for several legitimate reasons: to hold life insurance policies, to transfer ownership interests to the next generation over time, to provide liquidity during a transition, to manage estate tax exposure, and to protect assets while keeping them accessible for the business.

The specific type of trust, the income it generates, and how distributions are structured all affect how the new limitation applies. But the category of trusts subject to the rule is broader than most people assumed when the law was first covered.

Trusts affected by this limitation face a real choice. They can sell assets to pay the additional tax, which reduces the long-term value of what passes to heirs. Or they can reduce distributions to beneficiaries, which affects the people who depend on those distributions.

Neither outcome is what the business owner intended when the trust was established.

The bottom line: Existing trusts may need to be restructured, or distribution strategies may need to change. The impact is not just on what the tax bill looks like. It is on what actually transfers to the next generation.

WHO THIS ACTUALLY AFFECTS

The first instinct is to assume this only matters for large family dynasties with multi-million-dollar trust portfolios. That assumption is wrong.

A business owner who established a modest irrevocable life insurance trust to fund a buy-sell agreement may be affected. A family that used a trust to hold business real estate may be affected. A parent who funded a special needs trust with proceeds from a business transaction may be affected. Any trust generating taxable income above the $16,000 threshold is potentially within scope.

This is not a planning problem that resolves on its own, and it is not a future concern. The provision applies to existing trusts starting with income generated in 2026. For some business owners, the impact is already in motion.

The bottom line: This provision is not limited to ultra-high-net-worth estates. Any business owner with a trust generating $16,000 or more in annual income should understand how the new rule applies to that structure.

WHAT YOU CAN DO RIGHT NOW

Most business owners did not build their succession structure for tax reasons alone. They built it to protect what they spent decades creating, to keep the business in the right hands, and to provide for the people who depend on it. That is still the goal. The question the new law raises is whether the structure they chose to get there still works the way they intended.

The first step is a review. Every trust in the succession plan needs to be assessed for how the new limitation applies to its specific income level, distribution method, and legal structure.

There are real options. Some trusts can be restructured. Distribution strategies can be adjusted. In some cases, a different structure serves the original goals better under the new rules than the current one does. None of those paths looks the same for every business, and the right answer depends on the specifics of the trust, the income it generates, and what the owner is actually trying to accomplish.

This is exactly the kind of review a LIFT™ (Legal, Insurance, Financial & Tax) Business Planning Session is designed to surface. Business succession structures are built at one point in time, under one set of tax rules. When those rules change, the structure needs to be looked at again. A LIFT™ Business Planning Session brings together the legal, insurance, financial, and tax dimensions of the succession plan and identifies where changes in the law have created gaps or new exposure that was not there when the plan was originally built.

If your succession structure has not been reviewed since the One Big Beautiful Bill was signed, this provision is a reason to schedule that review now.

As a Personal Family Lawyer®, we don't apply a one-size-fits-all approach. We take the time to understand your specific business, your family, and what you have built, then work through the legal, insurance, financial, and tax structure that protects it. Most business owners work with a lawyer, an accountant, and a financial advisor separately. What we do differently is hold all four systems together, so a gap in one does not quietly undo the others. A LIFT™ Business Planning Session is where that conversation starts.

Schedule a complimentary 15-minute call with one of our experts, and let's make sure your succession structure is ready for what the new law requires.

This article is a service of Sky Unlimited Legal Advisory PC, Personal Family Lawyer® .  We're not your traditional law firm, we stand apart from the rest by helping you make informed and empowered decisions on how to deal with your business throughout life and in the event of an emergency. We offer a complete spectrum of legal services, including a New Business Planning Session or an Existing Business Review Session, which includes a review of all the legal, insurance, financial, and tax systems you need for your business. You can begin by calling our office at (650) 761-0992 today or book online to schedule a Business Planning Session and mention this article to find out how to get this $950 session at no charge.