Most trusts are subject to tax on their income at a flat rate equal to the highest marginal personal rate of tax. For example, if you set up a trust in Ontario during your lifetime and it earns and retains $100,000 of taxable income, it will be liable to pay about 53% tax on that amount.
Most trusts must also have a taxation year that is the calendar year (ending December 31).
One notable exception, where the high flat tax and the calendar year requirement do not apply, is a “graduated rate estate” (GRE). (An estate is treated as a trust for tax purposes.) A GRE is subject to tax at the same graduated tax rates that apply to individuals. A GRE can have any fiscal period as its taxation year, including an off-calendar year or the calendar year.
In general terms, a GRE is your estate that comes into existence upon and as a consequence of your death. Your estate can qualify as a GRE for up to 36 months after your death, generally if it does not receive contributions from other persons (the details regarding the “contributions” are quite technical).
Once the 36 months are up, the estate will be subject to the high flat tax. It will also have a deemed taxation year end immediately before the end of the 36 months, and after that point in time will be required to have a calendar year taxation year.
Because of the option regarding the taxation year, a GRE can have either three or four taxation years.
Example
A taxpayer dies on November 1, 2017.
If the taxpayer’s GRE (through the executor or estate trustee) chooses a calendar-year taxation year, its first taxation year will be short and will end on December 31, 2017. The estate will have two more taxation years ending at the end of 2018 and 2019, and one more taxation year ending on October 31, 2020 (36 months after the death), for a total of four taxation years.
If the GRE uses a 12-month fiscal period as its taxation year right from the start, the first taxation year will end on October 31, 2018. The next two taxation years of the estate will end on October 31, 2019 and 2020, respectively, for a total of three taxation years.
In either case, every taxation year ending after the estate is no longer a GRE will coincide with the calendar year end.
Note that the GRE is a separate taxpayer from the deceased. A T1 tax return will normally be required for the deceased for the year of death. A T3 (trust) tax return will normally be required for the GRE for each of its taxation years (and for the estate’s taxation years after it ceases to be a GRE, assuming it remains in existence).
The GRE rules, which took effect in 2016, replace the old rules that applied for “testamentary trusts”, meaning trusts set up by one’s Will. Under the old rules, a testamentary trust was generally subject to the low tax rates that apply to individuals. Now, a testamentary trust is normally taxed at the top marginal rate (with limited exceptions for a “qualified disability trust”).