Graduated Rate Estate vs Ordinary Trust Tax in Ontario

If you are the executor of an Ontario estate, income often keeps arriving after the death: interest, dividends, rent or gains on investments. How that income is taxed depends heavily on whether the estate qualifies as a graduated rate estate.

This article explains the 36-month idea in plain words, how it compares with an ordinary trust, and what to watch for with T3 returns. Tax rates change every year, so confirm current figures with an accountant.

Testamentary and living trusts: the starting point

For tax purposes, a testamentary trust is a trust or estate generally created on and because of a person's death. An inter vivos (living) trust is any trust that is not a testamentary trust.

An estate you administer is therefore generally a testamentary trust for tax purposes. A trust set up in the will to hold property for a spouse or child is also testamentary. Which tax treatment applies is where the graduated rate estate rules come in.

What a graduated rate estate is

A graduated rate estate (GRE) is the estate that arises on an individual's death. It can only be a GRE for up to 36 months after the death.

• There can be only one GRE for a deceased individual.
• The estate must designate itself as a GRE on its first T3 return.
• It must report the deceased's Social Insurance Number on its returns during the 36-month period.
• It has a deemed tax year-end on the day it stops being a GRE.

The deemed year-end is easy to miss. When the 36 months end, the estate has a tax year-end on that day, so plan for a return covering that period.

How this compares with an ordinary trust

Under Income Tax Act s. 122(1), a trust's taxable income is generally taxed at the highest individual percentage, the top personal rate. Graduated rate estates and qualified disability trusts are excluded from that rule.

Put simply, the first 36 months give the estate access to graduated rates, like an individual. After that, income left in the estate is generally taxed at the top rate. That is one reason executors are often encouraged to wrap up an estate within a reasonable time, though other factors also matter.

Qualified disability trusts and other points to know

A testamentary trust that arose on a death can also be taxed at graduated rates as a qualified disability trust (QDT). It must jointly elect with one or more beneficiaries on Form T3QDT and meet the other conditions. Whether a trust qualifies depends on its facts, so get tax advice.

Trusts also face a 21-year rule. Generally, a trust is deemed to dispose of its capital property at fair market value every 21 years. Spousal, alter ego and joint partner trusts have a different first date, tied to the beneficiary spouse's death or the later of the two deaths.

T3 returns and next steps

A trust must file a T3 return if it is a Canadian-resident express trust that is not a listed trust. Other trusts must file only if they meet conditions such as having tax payable or being asked to file. Trusts that existed for less than three months, or that held assets worth no more than $50,000 throughout the year, are among the listed trusts generally exempt from filing, though the list has been expanded and the current wording should be checked. A filing trust generally must also report beneficial ownership information on Schedule 15.

A T3 return is due no later than 90 days after the trust's tax year-end. The late-filing penalty is 5% of the unpaid tax, plus 1% of the unpaid tax for each full month the return is late, up to 12 months. Where no tax is owing, filing late costs $25 a day, with a minimum of $100 and a maximum of $2,500.

• Note the date of death and mark the 36-month point on a calendar.
• Confirm the estate will designate itself as a GRE on its first T3 return.
• Keep the deceased's Social Insurance Number available for the returns.
• Remember the deemed year-end when GRE status ends.
• Ask an accountant about current rates and whether any beneficiary trust could be a QDT.
• Keep estate records so each T3 can be filed on time.

Frequently asked questions