How a Spousal Trust Works and How It Is Taxed in Ontario

If you have a spouse and children from an earlier relationship, you may want your spouse looked after for life while the rest of your estate eventually reaches your children. A spousal trust set up in a will is one common way to try to do that.

This article explains what a spousal trust is in plain terms, who controls it, and how the tax deferral works. The details depend on your will and your finances, so treat this as background for a conversation with a lawyer and an accountant.

What a spousal trust is

A trust is a legal arrangement where a person you choose, called a trustee, holds and manages property for the benefit of someone else. A spousal trust is a trust whose main beneficiary is your surviving spouse or common-law partner.

For tax purposes, the kind that matters here is a qualifying testamentary spousal trust. It must be created by the deceased's will. A trust you set up while alive is a different thing and follows different rules.

Who controls it and who benefits

Your will names the trustee, and the trustee manages the property under the terms you write. That person can be your spouse, an adult child, a trusted friend or a trust company. Choosing someone is a real decision in a blended family, because the trustee may have to balance the interests of your spouse and your children.

To qualify for the tax rollover, the surviving spouse must be entitled to all the trust income arising before their death. No one else may receive or use trust income or capital during the spouse's lifetime. That strict rule is what gives your spouse security, and it also limits what you can do for your children while your spouse is alive.

What happens to the capital after your spouse dies is set by your will, which is how many people direct it to children from a prior relationship.

How the tax deferral works

At death, a person is generally treated as having sold their capital property at fair market value just before dying. If capital property passes to a testamentary spousal trust, the deceased is instead treated as selling at adjusted cost base. The capital gain on the final return is then zero.

The property must be locked in for the trust no later than 36 months after death. A written extension request can be made to the Tax Services Office before the 36 months end. The legal representative can also choose, property by property, to use fair market value instead of the rollover.

The tax is deferred, not erased. A spousal trust is treated as selling its capital property at the end of the day the beneficiary spouse dies, and that is when the deferred gain is taxed. How trust income is taxed from year to year depends on how the trust is run, so an accountant should confirm this for your situation.

Blended families: points to watch

A spousal trust does not stop your spouse from making other claims. A surviving married spouse can claim half the difference in net family property under the Family Law Act, take what the will gives, or, if there is no will, take their share under the Succession Law Reform Act.

• The survivor must file the Election of Surviving Spouse form with the Estate Registrar for Ontario no later than six months from the death.
• If no election is filed, the survivor is deemed to take under the will or intestacy.
• If the survivor elects equalization, gifts to them in the will are deemed revoked unless the will expressly says the gifts are in addition.
• Separately, a court may order adequate support out of the estate for a dependant who was not adequately provided for, and the limitation period is six months.

These rules are why the wording of a trust, and the other gifts in your will, should be planned together.

What to do next

• List your assets and note which are capital property, such as investments or a second property.
• Decide who you would trust as trustee, and a backup.
• Think through what your spouse needs for life and what you want your children to receive afterwards.
• Ask a lawyer to draft the trust wording so it meets the conditions, because a trust that does not meet them does not get the rollover.
• Ask an accountant to estimate the tax that could arise when your spouse later dies.

Frequently asked questions