Wow. I did not know that the trust instrument could give the trustee control on exactly what type of income was distributed, other than capital gains.
"“Instead of a strict pro rata allocation, a trust instrument may stipulate a certain order in which income items are distributed to the beneficiaries. Similarly, state law may indicate in what order income should be distributed.
If the trust instrument of the JSA Trust or state law indicates that taxable income must be distributed before tax-exempt income, the distribution would consist of $15,000 in taxable income, and the entire $4,881 net tax-exempt income would be allocated to the trust. The distribution deduction would be $15,000. On the other hand, if tax-exempt income is distributed first, the distribution would consist of $4,881 net tax-exempt income and $10,119 taxable income. The trust’s income would be $73,169 ($88,169 – $15,000) in the former example or $78,050 ($88,169 – $10,119) in the latter case.
Practice point. Because the tax rates of estates and trusts are likely higher than the tax rates of the individual beneficiaries, it is advisable (if possible) to retain the tax-exempt income and distribute taxable income only.”