Spousal Trust vs Alter Ego Trust: Key Differences in Ontario

If you are an older Ontarian planning for a partner, you may have heard of both spousal trusts and alter ego trusts. They sound alike, but they are different tools built for different goals, and they are taxed differently.

This article explains what is clearly set out for the spousal trust, then shows which questions to ask about an alter ego trust and about probate. Trust planning is detailed, so the final choice is best made with a lawyer and an accountant.

What a spousal trust is and who can use one

A spousal trust holds property for a surviving spouse or common-law partner instead of handing it over outright. It is often used when the person leaving the property wants to control where it goes after the survivor dies.

For the tax rollover, a qualifying spousal trust must be created by the deceased's will. The surviving spouse must be entitled to all the trust income that arises before their death, and no one else may receive or use trust income or capital during the spouse's lifetime.

The rollover is not limited to married couples. It applies to a surviving spouse or common-law partner resident in Canada, or to a testamentary spousal trust.

How a spousal trust is taxed on death

The starting rule is that a person is treated as having sold their capital property at fair market value immediately before death. That can create a large capital gain on the final return.

The spousal rollover is the exception. If capital property passes to a surviving spouse or common-law partner resident in Canada, or to a testamentary spousal trust, the deceased is treated as selling at adjusted cost base, so the capital gain on the final return is zero. The survivor or trust takes over the deceased's cost.

• The property must be locked in for the spouse or trust no later than 36 months after death, and a written extension request can be made to the Tax Services Office before the 36 months end.
• The legal representative can elect, property by property, to transfer at fair market value instead of using the rollover.
• A spousal trust is treated as selling its capital property at the end of the day the beneficiary spouse dies, which is when the deferred gain is taxed.

A trust that does not meet the conditions does not get the rollover. The cure under s. 70(7) is available only where the problem is testamentary debts. Careful drafting matters.

Where an alter ego trust fits

An alter ego trust is a different planning tool from a spousal trust, and it is worth understanding how the two differ before you compare them.

Comparing the two is easier once you know how each one is created and taxed. The eligibility requirements and the tax treatment on death for an alter ego trust depend on how it is drafted and on your age and circumstances. Ask a lawyer and an accountant to confirm them in writing before you transfer any property. Do not assume it follows the spousal trust rules above.

• Who can set it up, and at what age?
• Who must receive the income while you are alive?
• What happens to the property when you die, and who is taxed?
• Does the trust give up control you want to keep?

Probate, the will and a spouse's election

Probate tax is one of the main reasons people compare these trusts. Whether a trust reduces it depends on what property goes into the trust and how it is set up, so ask for a written estimate for your own estate.

A trust in a will also has to coexist with a married survivor's rights. A surviving spouse can claim half the difference in net family property under the Family Law Act, take what the will gives, or, with no will, take their share under the Succession Law Reform Act. The election form must be filed with the Estate Registrar for Ontario within six months of the death.

If the survivor elects equalization, gifts to them in the will are deemed revoked unless the will expressly says the gifts are in addition. That can undo the plan a spousal trust was meant to carry out, so the will wording matters.

What to do next

• List the property you want the trust to hold and note its original cost.
• Decide whether you want the trust to take effect during your life or only at death.
• Ask a lawyer how the trust would be drafted to meet the spousal trust conditions.
• Ask an accountant to estimate tax on death and the effect on probate for your estate.
• Review your will so it matches the trust and any survivor's election rights.

Frequently asked questions