Introduction

Professional liability insurance — errors and omissions (E&O) coverage, or malpractice insurance in the law context — is a substantial annual cost for lawyers and law firms. For incorporated lawyers, these premiums are a legitimate business expense of the professional corporation. How they are claimed, and how any insurance proceeds are treated if a claim is paid, involves some nuances worth understanding.

Deductibility of Professional Liability Premiums

Premiums paid for professional liability insurance that protects the lawyer's practice against claims arising from professional errors, omissions, and negligence are deductible as business expenses of the corporation under section 18(1)(a), provided the coverage relates to the professional practice generating income.

For an incorporated lawyer, the professional corporation pays the premium, and the expense reduces the corporation's net income before corporate tax is applied. This is the standard treatment for most professional liability coverage.

The Law Society of Ontario requires that lawyers carry professional liability insurance through the Law Society's program. The mandatory LawPRO premium is clearly deductible as a professional expense — it is a regulatory requirement of practising law in Ontario and directly relates to the professional income-earning activity.

Additional coverage — excess or top-up policies purchased beyond the mandatory minimum — is deductible on the same basis, provided it relates to professional practice.

Premiums in a Personal Service Context

For a lawyer who operates as an unincorporated self-employed individual, professional liability premiums are deductible on Form T2125 of the T1 personal return, reducing net self-employment income.

For a law firm partnership, the premiums are a deductible partnership expense, allocated to partners as part of the overall partnership income or loss calculation.

Run-Off Coverage

When a lawyer retires or ceases practice, professional liability claims can still arise for work performed during the practice years — sometimes years after the last file was closed. Run-off coverage (also called tail coverage) provides ongoing protection for this extended exposure.

For tax purposes, run-off coverage premiums are deductible in the year paid, provided the coverage relates to professional activities that were part of the income-earning practice. A lawyer who retires and pays several years of run-off premiums may be able to deduct those premiums, but the specific analysis depends on whether the professional practice is considered to have ceased and whether a continuing business source of income exists.

This is an area where CPA input — and coordination with the lawyer's professional liability insurer — is advisable.

Tax Treatment of Insurance Proceeds

When a professional liability claim is paid by the insurer, the proceeds may or may not be taxable, depending on what the payment represents.

Proceeds compensating for a business loss: If the insurance proceeds compensate the lawyer or the corporation for a business expense or loss (for example, reimbursing legal costs of defending the claim), the proceeds are generally included in income to the extent the original expense was deducted.

Proceeds for damages paid to a third party: Where the insurer pays a settlement or judgment on behalf of the insured to a third party (the claimant), the payment passes through the insured's accounts but does not represent income to the insured. The insurer pays the claimant directly or reimburses the insured for amounts paid.

Proceeds for physical damage to property: Not typically applicable for professional liability claims.

The specific tax treatment depends on the nature and structure of the claim, and how the proceeds are characterised in the settlement documents. For significant professional liability claims, the CPA should be involved in reviewing the tax consequences of any settlement.

Documentation

The CRA expects professional liability insurance premiums to be supported by the insurer's invoice or premium notice. For firms with multiple policies or multi-year premiums, accurate records of what was paid in each tax year support the deduction in the correct year.

When to Speak With a CPA

For lawyers with significant professional liability costs — particularly those considering run-off coverage on retirement or who have received insurance proceeds in respect of a settled claim — a CPA review ensures the expense and any recoveries are treated correctly.

Rotaru CPA works with lawyers and incorporated legal practices on professional expense planning and corporate compliance. Book a consultation to discuss your insurance deductions.