"
This means all of the income and principal (if interest does not cover the 3% payout) will be distributed."
A trust whose governing instrument requires that all income be distributed currently is allowed a $300 exemption,
even if it distributed amounts other than income during the tax year.
See https://www.irs.gov/instructions/i1041/ch02.html#d0e3675 and IRC §642(b)(2)(B)
Since the "governing instrument" now appears to be a settlement agreement that requires all income be distributed currently, the trust should be entitled to the $300 exemption.
