When a solicitor or law firm ceases to practise, the regulatory obligations do not end on the last day of trading. The Solicitors Regulation Authority (SRA) requires all firms to hold run-off professional indemnity insurance (PII) for at least six years after cessation. This is known as the six-year run-off period. The cost of these premiums can be significant, often running into tens of thousands of pounds. Understanding the tax treatment of run-off cover is essential for partners, members, and directors to avoid unexpected tax charges or missed deductions.
This article explains how run-off cover premiums are treated for tax purposes when a law firm ceases. We cover the distinction between cessation cover and run-off cover, the rules for partnerships and LLPs, and the position for incorporated firms. We also address the common question of whether run-off premiums can be deducted in the final period of trade or only after cessation.
What Is Run-Off Cover for Solicitors?
Run-off cover is a type of PII policy that covers claims made against a law firm after it has stopped practising. The SRA Minimum Terms and Conditions (MTC) require every firm to maintain run-off cover for at least six years from the date of cessation. This applies regardless of whether the firm was a sole practitioner, partnership, LLP, or company.
There are two main types of post-cessation cover:
- Cessation cover, a single policy taken out at the point of closure that covers the entire six-year run-off period. The premium is paid upfront.
- Annual run-off cover, a series of annual policies renewed each year during the six-year period. Premiums are paid annually.
The choice between these two options depends on the insurer and the firm's circumstances. Some insurers offer a discounted premium for a single cessation policy. Others require annual renewals. The tax treatment differs depending on which option is chosen and the legal structure of the firm.
Tax Treatment of Run-Off Premiums for Partnerships and LLPs
Partnerships and LLPs are tax-transparent entities. This means the partners or members are taxed individually on their share of the firm's profits. The firm itself does not pay corporation tax. When a partnership or LLP ceases to trade, the tax rules for deducting expenses change.
Deductibility of Run-Off Premiums Paid Before Cessation
If the firm pays a run-off premium before the date of cessation, the cost is treated as an expense of the trade. It is deductible in computing the partnership or LLP's profit for the final period of account. This is straightforward because the expense is incurred while the trade is still being carried on.
For example, a five-partner LLP ceases practice on 31 March 2026. The LLP pays a cessation cover premium of £60,000 on 15 March 2026. The full £60,000 is deductible in the final profit computation for the period ending 31 March 2026. Each partner's share of the deduction is £12,000, reducing their taxable profit for that year.
Deductibility of Run-Off Premiums Paid After Cessation
If the firm pays run-off premiums after the date of cessation, the position is more complex. The trade has ended, so the expense is not incurred in the course of the trade. However, HMRC accepts that certain post-cessation expenses can be deducted against post-cessation receipts.
For partnerships and LLPs, post-cessation run-off premiums are treated as a post-cessation expense under Section 96 ITTOIA 2005. This allows the partners or members to claim a deduction against any post-cessation receipts they receive. If there are no post-cessation receipts, the expense is effectively wasted from a tax perspective.
This is a common trap. A firm that pays annual run-off premiums after cessation may find it cannot deduct them if it has no post-cessation income. The solution is often to pay the run-off premium before the date of cessation, even if the policy covers a period after cessation. HMRC has confirmed in guidance that a premium paid before cessation is deductible as a trading expense, provided it relates to the firm's trade.
Practical Tip for Partners and Members
If you are planning to cease practice, consider paying the run-off premium before the cessation date. This ensures the cost is deductible in full against trading profits. If the premium is paid after cessation, the deduction is limited to post-cessation receipts, which may be minimal or nil.
This is particularly relevant for sole practitioners and small partnerships where post-cessation receipts are often limited to residual WIP collections or rebates. A practice valuation exercise can help quantify likely post-cessation income and inform the decision.
Tax Treatment of Run-Off Premiums for Incorporated Law Firms
For law firms structured as limited companies, the tax treatment is different. The company continues to exist after cessation of trade, even if it is dormant. The company can deduct run-off premiums as a trading expense if they are incurred before the trade ceases. If the premium is paid after cessation, it may still be deductible as a management expense or as a post-cessation expense, depending on the company's activities.
In practice, most incorporated law firms pay the run-off premium before cessation to ensure deductibility. The company's corporation tax computation for the final period of account includes the premium as a trading expense. This reduces the company's taxable profit and, therefore, the corporation tax liability.
If the company has already ceased trading and pays a run-off premium later, the expense is treated as a non-trading debit. It can be set against any non-trading profits of the company, such as bank interest or rental income. If there are no such profits, the expense is carried forward and may be lost if the company is dissolved.
Interaction with Cessation of Trade and Overlap Relief
For partnerships and LLPs, the cessation of trade triggers a final profit computation. Any overlap relief (from when the firm started or changed its accounting date) is deducted in the final year. This can reduce the partners' tax bills significantly. However, if the firm has significant run-off premiums to pay, the interaction with overlap relief needs careful planning.
Consider a solicitor who joined a partnership in 2015 and had overlap relief of £20,000. The firm ceases in 2026. The final year profit share is £100,000, but the firm also pays a £30,000 run-off premium. The partner's net profit share is £70,000. Overlap relief of £20,000 reduces this to £50,000. The partner pays tax on £50,000 rather than £100,000. This is a significant saving.
However, if the run-off premium is paid after cessation, the partner's final year profit share remains £100,000, and the overlap relief still applies. The post-cessation premium is then only deductible against post-cessation receipts, which may be minimal. The partner loses the benefit of the deduction in the final year. This illustrates why timing matters.
Run-Off Cover for Locum Solicitors and Consultants
Locum solicitors and consultant solicitors who work through their own limited company or as sole traders also need run-off cover when they stop providing legal services. The same principles apply. If the locum ceases to trade, the run-off premium should ideally be paid before cessation to ensure deductibility.
For locums operating through a personal service company (PSC), the company pays the premium. If the company ceases trading, the premium is deductible in the final corporation tax computation. If the company continues to exist but the locum stops working, the premium may still be deductible as a trading expense if the company remains in business.
For locum solicitors who are self-employed sole traders, the rules are identical to those for partnerships. The premium must be paid before cessation to be fully deductible. If paid after cessation, it is only deductible against post-cessation receipts.
We cover this in more detail in our guide on professional indemnity tax treatment for solicitors.
VAT on Run-Off Premiums
PII premiums are exempt from VAT for insurance purposes. However, insurance brokers often charge a fee for arranging run-off cover, and that fee is subject to VAT at 20%. The firm can recover this VAT if it is VAT-registered and the fee relates to its taxable business activities.
After cessation, the firm may deregister for VAT. If the firm deregisters before paying the run-off premium, it cannot recover the VAT on the broker's fee. This is another reason to pay the premium before cessation, while the firm is still VAT-registered.
Common Mistakes and How to Avoid Them
We see several recurring errors when advising law firms on run-off cover tax treatment:
- Paying the premium after cessation, This limits deductibility for partnerships and LLPs. Pay before cessation if possible.
- Ignoring the six-year run-off requirement, Some firms assume they can cancel PII immediately on cessation. This is a breach of SRA rules and can lead to regulatory action.
- Failing to budget for the premium, Run-off premiums can be substantial. Firms should factor this into their cessation planning and cash flow forecasts.
- Not considering the VAT position, If the firm deregisters for VAT before paying the premium, it loses the ability to recover VAT on broker fees.
- Assuming all partners are treated the same, In an LLP, the salaried member rules may affect how deductions are allocated. Fixed-share partners and equity partners may have different tax positions.
Planning for Cessation: A Checklist for Solicitors
If you are a solicitor or law firm partner planning to cease practice, consider the following steps:
- Confirm the SRA run-off cover requirements with your COFA or compliance officer.
- Obtain quotes for cessation cover and annual run-off cover. Compare the total cost over six years.
- If possible, pay the premium before the date of cessation to ensure full tax deductibility.
- Check your VAT registration status and plan the timing of deregistration.
- Calculate your overlap relief and factor it into the final year tax computation.
- Consider the impact on each partner's personal tax position, including any capital gains on the sale of goodwill.
- Review your COFA compliance support needs during the run-off period.
Conclusion
The tax treatment of run-off cover for solicitors and law firms depends on the timing of the premium payment and the legal structure of the firm. For partnerships and LLPs, paying the premium before cessation is critical to ensure full deductibility against trading profits. For incorporated firms, the same principle applies, but there is more flexibility if the company continues to exist after cessation.
Run-off cover is a mandatory cost of ceasing practice. With careful planning, you can ensure that the tax relief is maximised and that your final tax bills are as low as possible. The key is to act before the cessation date, not after.
Every firm's circumstances are different. The rules around cessation cover, six-year run-off periods, and run-off premium deductibility can be complex, especially when multiple partners or members are involved. We recommend speaking to a legal-sector-specialist accountant who understands the specific tax treatment of run-off cover for solicitors and law firms.
If you are planning to cease practice or are considering your options, contact us for a confidential discussion. We can help you structure the cessation to minimise tax and ensure full compliance with SRA requirements.