Donna creates an irrevocable trust that has the primary purpose of holding a $500,000 life insurance policy on her life. The trustee, ABC Bank and Trust Company, holds no other principal. The trust is intended to avoid inclusion of the death benefit in her gross estate. She has three children as the primary beneficiaries and the trust will not terminate until the death of the survivor of her children. The trustee is given the power to distribute income for the primary beneficiaries at the trustee’s sole discretion. At the termination of the trust, the remaining principal is to be distributed to her grandchildren in equal shares, per stripes. To qualify her gifts to the trust for the annual gift tax exclusion, the trust provides that each of her three children shall have the noncumulative right to withdraw his or her pro rata share of the annual gifts to the trust, however, if the withdrawal right is not exercised, it lapses in 30 day. Donna makes $15,000 gifts to the trust annually for the remainder of her lifetime to pay the premiums on the policy. The children never exercise any withdrawal rights. At her death, the $500,000 death benefit is invested by trustee in income-producing property. In the first year after her death, the trustee distributes all income to her children in equal shares. In the second year following her death, the trust has taxable income of $30,000, but only distributes $15,000 in equal shares to her children.

What is the tax treatment of the trust and the beneficiaries during these tax years?