Lawyer tax services: PC returns, WIP after section 34, and HST on legal fees

The professional corporation T2, with Ontario's catch

A law professional corporation delivers one main benefit: earnings you leave inside it are taxed at Ontario's combined 12.2% small business rate on the first $500,000 instead of personal rates above 53% at the top bracket. For a practice throwing off more than you spend, that deferral compounds meaningfully. But be clear-eyed about the catch — under LSO rules, every shareholder must be a licensee. Unlike physicians and dentists, you cannot put non-voting shares in a spouse's hands, so the income-splitting pitch you may have heard from a colleague in medicine does not transfer.

Two more things we watch on every PC file. Passive income above $50,000 inside the corporation starts grinding away the small business limit, which matters once retained earnings build an investment portfolio. And incorporation does nothing for malpractice exposure — professional liability follows you personally, so the decision is a tax decision, not an asset-protection one.

WIP after section 34: the election is gone, valuation is the game

For decades, section 34 let lawyers elect billed-basis accounting — unbilled work-in-progress simply was not income until you sent the bill. The 2017 federal budget killed the election for taxation years starting after March 21, 2017, phased in over five years. That transition is fully behind us: WIP is now taxable inventory, and pretending otherwise on a T2 or T1 is a reassessment waiting to happen.

What remains is valuation, and it is genuinely favourable if done carefully. WIP goes in at the lower of cost and fair market value — and cost means the direct cost of producing the unbilled work: associate and clerk salaries, direct file expenses. For a sole practitioner with no staff, the cost of your own unbilled time is close to nil, so the inclusion is often far smaller than the docketed value. Contingency files are cleaner still: until the outcome that creates a right to bill, CRA accepts that the WIP has no determinable value. We document the valuation method once and apply it consistently, which is what a reviewer wants to see.

Partners are taxed on allocations, not draws

If you practise in a partnership, your tax is driven by your allocated share of firm income at the fiscal year-end — not by what you drew. A partner who took modest draws in a strong firm year still owes tax on the full allocation, and the gap surprises people every April. We reconcile the firm's allocation (reported on T5013 slips at most multi-partner firms) to your capital account and your draws, so the personal instalments we set actually match the liability that is building.

Partnerships of individuals must generally use a December 31 year-end, which at least keeps the firm's income and your T1 on the same calendar. New partners have extra moving parts — buy-in structure, capital contributions, and the first year of instalments on partnership income — that we plan before the admission date, not after.

HST on legal fees, retainers, and disbursements

Legal services carry 13% HST in Ontario, and the tax is generally collectible when you issue the account — a retainer sitting in trust is not consideration until it is applied to a bill. Disbursements are where firms remit wrongly in both directions, and the distinction is agency: costs you incur as agent for the client flow through without HST added, while costs you incur as inputs to your own service get taxed when recharged.

That last row deserves care: zero-rating US and other foreign clients is real money, but the carve-outs are specific, and the paperwork proving non-residence has to be on file. If a meaningful slice of your practice bills American clients, the withholding and treaty side of that revenue is covered on our cross-border tax page for lawyers.