Living Trust vs Testamentary Trust in Ontario Explained

If you are trying to understand a trust that someone has set up, or that you have been named in, you will quickly meet two labels: inter vivos and testamentary. They sound technical, but the difference mostly comes down to when and why the trust began.

The label matters because it affects how the trust is taxed, when it must report, and what special rules may apply. This article explains the two types in plain language so you can ask better questions of the estate trustee, the accountant or a lawyer.

The basic difference

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

In other words, the law defines living trusts by exclusion. If a trust did not arise on and because of a death, it falls into the living category. Someone sets up a living trust while they are alive. A testamentary trust comes into being as a result of a death.

How the two types are generally taxed

As a general rule, a trust's taxable income is taxed at the highest individual percentage, the top personal rate. Graduated rate estates and qualified disability trusts are excluded from that rule.

A graduated rate estate (GRE) is the estate that arises on an individual's death, and it can only be a GRE for up to 36 months after the death. There can be only one GRE for a deceased person. It must designate itself as a GRE on its first T3 return and report the deceased's Social Insurance Number on its returns during that period. A GRE has a deemed tax year-end on the day it stops being a GRE.

A testamentary trust that arose on a death can also be taxed at graduated rates as a qualified disability trust. It must jointly elect with one or more beneficiaries on Form T3QDT and meet the other conditions.

Side-by-side comparison

The 21-year rule and its exceptions

Generally, a trust is deemed to dispose of its capital property at fair market value every 21 years. That can create a tax bill even though nothing was actually sold, so long-lived trusts need planning.

Spousal, alter ego and joint partner trusts are treated differently. For these, the first deemed disposition happens on the day the beneficiary spouse dies, or on the later of the two deaths, rather than on the usual 21-year date.

• An alter ego trust is a living trust created after 1999 by a settlor who was 65 or older, and the settlor must be entitled to all of the trust's income during their lifetime.
• A joint spousal or common-law partner trust is a living trust created after 1999 by a settlor aged 65 or older, where the settlor and their spouse or partner are entitled to all of the income until the later of their deaths.
• Property left by will to a spouse or common-law partner trust can pass at cost, a tax-deferred rollover, if the survivor is entitled to all of the trust's income for life and no one else may receive or use the income or capital during that lifetime.

For the rollover, the property must vest indefeasibly in the spouse or the trust within 36 months after the death, although the Minister may allow a longer period if a written application is made within that time.

Reporting duties for both types

A trust must file a T3 return if it is a Canadian-resident express trust that is not a listed trust. Other trusts 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, although the list has been expanded recently and the current wording is worth confirming.

A trust that must file generally also reports beneficial ownership information on Schedule 15. The T3 is due no later than 90 days after the trust's tax year-end.

What to do next

• Find the trust document and confirm when and how the trust was created.
• Ask whether the trust is an estate that may qualify as a graduated rate estate, and note the 36-month window.
• Note the trust's year-end and any T3 filing dates.
• Check whether it is a spousal, alter ego or joint partner trust, since the timing of the deemed sale differs.
• Speak with a lawyer or accountant before relying on any tax treatment, as the answer depends on the trust's exact terms.

Frequently asked questions