What happens when a Trust distrubutes income?

A trust is a separate legal entity for income tax purposes, and must file its own tax forms. A trust that is required to distribute all its income currently is considered a simple trust; otherwise the trust is a complex trust.
A trust figures its income and deductions much in the same way that an individual figures his or her income for tax purposes with one major difference. A trust is allowed a deduction for income distributed to beneficiaries. The income distribution deduction is figured by completing Schedule B of Form 1041. The beneficiary, not the trust, pays the income tax on the taxable amount of the distributions.
Generally, if an amount is distributed from a trust, that amount is considered to come out of current-year income first, then from accumulated capital or principal. Accumulated capital would be the original contribution, or contributions, to the trust plus all subsequent accumulations (i.e., income in excess of distributions).
Current income is figured under the state law applicable to trusts and the trust's governing document. Generally, the only distinction in accounting income under local law and regular net income would be the treatment of capital gains. If you have capital gains, you need to determine if they're taxable to the trust or the beneficiary.
When you distribute some or all of the trust to your beneficiaries, the income will be taxed to them, and accordingly you will need to complete a Schedule K-1 for them. They will include the K-1 amounts on their individual return. It is hoped they saved some money for taxes. The trust must claim the distribution deduction and pass the tax burden on to the beneficiary.

The full amount distributed is shown on Schedule B and is not required to be shown on the Schedule K-1. All amounts distributed to your beneficiaries or for their benefit are taxable to him to the extent of the trust's income distribution deduction. If you don't have capital gains or alternative minimum tax differences, the two pages of form 1041 and the schedule K-1 would be a complete tax return.