Testamentary and Spousal Trusts in Ontario: How They Work and Are Taxed

A testamentary trust is a trust created by a will and starting on death. Instead of leaving assets outright, the will directs the estate trustee or another trustee to hold them for a spouse, a child or another beneficiary. If you are a beneficiary or a trustee, you need to know how it operates and how it is taxed.

This article covers the trustee's duties, the main tax rules for estates and trusts, money held for children, and reporting. Tax rules in this area change, so a lawyer or accountant should confirm the current position before you act.

What a trustee must do

A trustee must invest trust property with the care, skill, diligence and judgment of a prudent investor (Trustee Act s. 27(1)). This applies, for example, to an inheritance held in trust for a minor.

If a trustee breaches the trust, the court may relieve them wholly or partly from personal liability if they acted honestly and reasonably and ought fairly to be excused. Investment losses are dealt with separately under section 35(2).

No Ontario law requires an estate trustee to pass accounts at fixed intervals, and an estate trustee need not pass accounts unless the court compels it at the request of a person with an interest, such as a beneficiary or creditor. On a passing, the judge may make a full inquiry into the whole estate and look into complaints of misconduct, neglect or default. Keeping clear records from the start protects everyone.

Tax on death and the spousal trust

At death, a taxpayer is deemed to have disposed of each capital property immediately before death for proceeds equal to its fair market value. That deemed disposition is deferred if the property passes to a spouse or common-law partner resident in Canada, or to a Canadian-resident trust created by the will.

The trust qualifies only if the spouse is entitled to all of its income and no one else can receive or use its income or capital during the spouse's lifetime. The property must also vest indefeasibly within 36 months after death. A spousal or common-law partner trust is deemed to dispose of its capital property at fair market value on the day the spouse dies.

How the trust and beneficiaries are taxed

• A trust may deduct income that became payable to its beneficiaries in the year, so that income is taxed to the beneficiary rather than the trust.
• Other trusts face a deemed disposition every 21 years.
• Since 2016, only graduated rate estates (and qualified disability trusts) are taxed at graduated rates, and other testamentary trusts pay the top rate.
• An estate stops being a graduated rate estate if it still exists 36 months after the death.

In practice, this means a trust is usually most tax-efficient when income is paid out to beneficiaries, but that must be balanced against the purpose of the trust. An accountant can model the options.

Money held for a child

Parents are not automatically entitled to receive and manage a child's money. That authority comes only from a court order appointing a guardian of property, and the application must be served on the Office of the Children's Lawyer. In most cases where a child is to receive $35,000 or less, the money does not have to be paid into court and can be paid to the parent the child lives with or to a person with lawful custody.

Amounts of $35,000 or more must generally be paid into court, unless a trustee is named in a legal document such as a will or a guardian of property has been appointed. That is one reason parents often name a trustee in a will. Money paid into court is held by the Accountant of the Superior Court of Justice and paid out at 18, or at a later age set by a will, trust deed or court order. The Accountant charges 3% on receipts and disbursements and a care and management fee of 0.60% a year, with no fee on the first payment in for a child and a cap so fees never exceed the month's interest.

Reporting for trusts

Bare trusts do not have to file a T3 return or Schedule 15 for taxation years ending on or after December 31, 2024 and before December 31, 2026. Reportable bare trusts may have to file for taxation years ending on or after December 31, 2026. The CRA has recently updated its trust reporting guidance, so check its current position.

Some arrangements are not reportable bare trusts, including those where each beneficiary is also a legal owner, where the legal owners are related individuals and the property is a principal residence, or where the owner holds the property because of a court order. A trust that has existed for less than three months, or whose assets never exceed $50,000 in fair market value during the year, is a listed trust and need not file Schedule 15 unless asked. A graduated rate estate is also a listed trust, but it may still have to file a T3 return.

What to do next

• Read the trust terms in the will and identify who the trustee, income beneficiaries and capital beneficiaries are.
• Open a separate trust account and keep a record of every receipt and payment.
• Ask an accountant whether the trust qualifies as a spousal trust or graduated rate estate.
• Confirm current CRA filing requirements before each year-end.
• Get legal advice before paying out capital, changing investments or if beneficiaries disagree.

Frequently asked questions