"I am delighted to have agreed a new deal and I look forward to recovering from injury and playing next season," said Wallace, who scored 439 points in 188 outings overall for the Irish province.
"This Ulster squad is the strongest that I have been involved in and I have no doubt that we will be competing for silverware next year. I want to be a part of that and hopefully become the first player to make 200 appearances for the province."
David Humphreys, Ulster's Director of Rugby, said: "Paddy Wallace has unrivalled experience and knowledge of the game.
"It was important for us to keep him, not just for his playing ability, but also for the significant role that he fulfils in mentoring the young players that we have coming through."
Meanwhile back-row forward Mike McComish has signed a two-year contract extension that will see him remain at the club until 2015.
And former Ulster players James McKinney and David McIlwaine have agreed contracts to return to Ulster.
"It is now more important than ever to have a strong panel of players to be able to compete in both the league and Europe," added Humphreys. "These four players will add considerably to our strength in depth for next season."