Trust accounting: The need to keep track of client funds given in trust separately from law firm operating funds. I don’t know if there is any concept more feared and mythologized by lawyers when it comes to running a small firm. And with good reason: practice for a few years and you’ll undoubtedly hear horror stories of that one attorney that made a mistake—just that one time—and lost their privilege to practice law.
Conceptually, trust accounting is simple: Keep money that isn’t yours in a separate account so that you don’t accidentally spend it. This includes unearned fees (typically paid as a retainer), settlement funds, or advanced costs and court fees.
In practice, it is far less simple. Attorneys striking out on their own—either as newly minted bar members or as veteran attorneys hanging their own shingle—will have to deal with a frustrating obstacle course of bar rules, plus a system of banks and credit card processors that are far too often ignorant of said rules. If you, or your bank, make one mistake, it could mean your license.
Here are a few points to keep in mind for trust accounting at your law firm to set yourself up for success.
Trust accounting best practices
The first best practice? Have an account. In some states you can’t even practice without one, not even if it’s for pro bono work.
The second best practice? Try to use it as little as possible. With trust accounting being a malpractice trap, many attorneys choose to structure their fees and payment plans to avoid using their accounts. Avoiding trust accounts means less bar oversight, less accidents jeopardizing one’s license, and fewer funds transfers between accounts.
For example, in a recent discussion on a listserv regarding a change in Missouri’s trust account rules (a new exemption allows lawyers to forego their trust account for flat-fee services under $2,000) one attorney decided to keep her flat fee amount under $2,000, while another stated that he charged an “intake fee” at the start of the case and the remainder of the flat fee was under $2,000, and therefore exempt. Whether or not charging such an “intake fee” doesn’t count as part of this limit is exactly the sort of murky trust account question that keeps lawyers up at night, by the way.
Assuming, like many attorneys, you can’t avoid using a trust account, this is the general flow for trust accounting:
- Client or third-party (such as an insurance company) hands your office a check for money that is not yours—unearned legal fees, settlement money, etc.
- You deposit this money into your trust account. Depending on your state’s rules, if the sum is large enough and belongs to a single client, you may be obligated to open a new interest-bearing trust account solely for that client. Otherwise, it goes into your normal, pooled attorney trust account.
- As funds are earned by you, or required to pay off fees, expenses, or third-party claims, you typically will write a check from your trust account to pay the amount into your operating account (or electronically transfer yourself your earned fees).
- When a case ends, and all claims are settled, any remaining amount is refunded to the client.
- If there is a dispute over your fees, and you have client money in the trust account, check with your state bar—many require you to hold that money in the trust account while the fee dispute is handled.
- Most states have a trust account reconciliation requirement. North Carolina, for example, requires attorneys to reconcile bank statements with their in-house ledgers or other record-keeping systems every quarter. Doing this regularly is a must—state bars are far more lenient when it comes to trust mistakes if the issue is detected quickly, if it is self-reported, and if it is clear that the lawyer’s office has been diligent about recordkeeping.
Opening a trust account
When it comes to opening an account, I was advised, when starting out, to open my operating account and trust account at different banks so that I would never confuse the two and accidentally deposit client funds into my operating account.
There are two big issues with that advice: first, you’ll have to visit multiple banks, which may be a headache, depending on where you practice. Second, there really isn’t any money to be made by a bank in managing lawyer trust accounts, since they can’t charge surprise fees and such, and balances are often low. This means many banks simply won’t want your business.
An easier solution is to simply get different-colored checks for your trust account and operating account, with TRUST ACCOUNT written in a very noticeable font on the trust checks.
If you practice in multiple states, beware that you are in for a major headache. As far as I can tell, all banks require you to go, in person, to a branch that is physically located in the state in which you wish to open an account.
I’m licensed in California, Missouri, Iowa, Kansas, North Dakota, New York, and New Jersey. (Why? It is a long story involving a midwestern boy falling for a medical student in Los Angeles and marrying her in New York City during her residency), If I want to take on clients in those states, I have to open five trust accounts in five states in person. Two of those states, Missouri and North Dakota, wisely allow attorneys to use trust accounts established in other states.
One final note: Many bank branch workers are unfamiliar with lawyer trust accounts and will try to get you to sign up for a regular checking account. This has happened to me personally in multiple banks in New York and New Jersey. I’ve had to cross state lines multiple times to try to get my accounts set up and have been advised by bank staff to do incredibly dumb things, like put an opening deposit of my own money into the trust account. If that happens, walk away from that bank quickly. Your state may have a trust accounting phone line that you can call, from the bank if necessary, to make sure you are setting things up the right way.
IOLTA, IOLA, or Attorney Trust? What’s the difference?
All three of these types of accounts (IOLTA, IOLA and Attorney Trust) have the same purpose: to segregate client funds from your typical business or operating account. The difference is simply in the interest—how much accumulates and who gets it. And no matter what your trust account is called, be adamant with the bank that fees cannot be charged to that account. A separate operating account or credit card should pay all fees so that client money is never touched.
IOLTA (Interest On Lawyer Trust Account) and IOLA (Interest on Lawyer Account) are the same thing, with different names. Most states use the IOLTA name, while New York, which has an affinity for odd legal naming schemes, uses the IOLA moniker. IOLTA/IOLA accounts are trust accounts that collect interest, then forward the collected interest to the state bar, typically to fund access to justice services.
Attorney Trust accounts are a third type of account, which may or may not be interest-bearing. For most attorneys, a non-IOLTA trust account is used for an individual client with a large balance on hold, such as a personal injury payout. If the account accrues interest, that interest goes to the client.
New Jersey, interestingly, has a two-stage Trust/IOLTA system: If your typical balance is under $2,500 per month, they instruct the attorney to have an ordinary Attorney Trust account. If the balance is regularly over $2,500, the attorney must register the account with the state bar and it will be converted to an IOLTA account.
Difference between trust and operating accounts
Let’s keep it simple: The trust account is for client funds only. The operating account is the law firm’s money. Period.
Except there is one small caveat: Some states will allow the attorney to deposit a nominal amount of money into the trust account to cover any fees that arise, whereas other states require any fees to be paid out of the separate operating account and do not allow a single cent of lawyer money in the IOLTA account.
For a typical evergreen retainer situation, you will take the client’s retainer amount and put it into your trust account. After each billing cycle, you calculate what is owed by the client to the firm and transfer that amount from the trust account to the operating account. If the retainer runs low, you ask the client to replenish the trust account. If there are any client funds left when the case is wrapped up, they are refunded to the client.
And for cases where large payouts happen—your typical personal injury settlement, for example—you take the settlement funds, put them in a trust account, then satisfy any liens (medical bills, medicaid, etc.). You pay yourself the contingency fee, of course, plus any costs. Then you cut a refund check to the client for whatever is left.
Trust accounting and ethics
If you follow the aforementioned procedures, and read the copious literature each state bar produces around local rules, you should be fine. Though most states work off of the ABA Model Rules, just go to your state bar’s website and find the local ones—they do differ enough on the fine details, like record retention policies, that it is worth the extra time to check each state in which you practice.
And if a mistake does happen, your best course of action is likely to self-report the mistake and immediately correct it. I’ve read dozens of ethics cases around trust accounting and most trust mistakes fall into one of these categories:
- An attorney, often with a substance abuse or gambling issue, “borrows” client funds from a trust account;
- Someone in a law firm (e.g., a member of the support staff) fails to learn the rules and comingles client and lawyer funds in either the trust or operating accounts.
- A minor clerical error or two, usually a result of sloppy office procedures, results in comingling of funds and the firm does not self-report, but does correct the error. The bar finds out later due to an unrelated ethics complaint and punishes the firm for the failure to report.
A friend of mine fell into the second bucket. Though she was a great lawyer, she never familiarized herself with California’s trust accounting rules and commingled earned fees and personal funds with client funds in the trust account. The bar found out when a check for personal expenses bounced and she was suspended until she could complete a series of CLE courses on trust accounting, plus study for and pass the Multistate Professional Responsibility Exam (MPRE)—the test they make law students take before bar admission. Two years later, she is still trying to complete the requirements for reinstatement.
Can I accept credit cards?
Can you afford not to? Seriously, don’t fear credit cards. Though state ethics rules can make credit card payment needlessly complicated, using a law-specific vendor for credit card processing removes most of the worries. The biggest and most well-known is LawPay, by Affinipay. Clio Payments is powered by LawPay, in fact, and if you use Clio Manage, Clio payments makes it incredibly easy to sync your payments records with your practice management system. Two other options that claim to be trust account-friendly are Headnote and Lex/Actum.
These vendors stay trust-friendly by charging credit card processing fees and any account fees to your operating account and they will not surprise you by charging fees or clawing back funds from your client trust account.
Other options for taking credit cards may not be able to fulfill these same promises. For example, when I started out, I used a Square reader on my smartphone—the little white box that fits in your headphone jack that you might see at a food truck. It was great, but I only used it for earned fees, as they didn’t have an option to charge fees to a separate account.
Of course, you’ll still have to watch the ledgers and reconcile your trust account regularly, as you would with checks and cash. But in a world where cash and checks are increasingly rare, not taking credit cards out of fear of ethics compliance could cost you a lot of business.
Tools to help with trust accounting
Accounting is probably the worst part of running your own law firm. Many attorneys turn to QuickBooks or Xero for managing their accounting and recordkeeping, rather than Excel spreadsheets. QuickBooks and Xero integrate with Clio Manage, which will save time on data entry.
I used Wave when starting out, as it is free. It does not integrate with Clio but could pull my bank account ledgers from the banks’ websites directly. I would still have to reconcile those ledgers with the trust records in Clio to make sure there were no mistakes.
For trust accounting and client-level transactions, Clio Manage’s trust accounting features track microledgers (client and matter-level transactions) and make reconciliation relatively easy.
Another far more important tool is your state bar. As I mentioned before, state bars produce an unfathomable amount of literature, CLEs, and seminars on how to manage trust accounts due to it being such a common ethics issue. If you are like me and licensed in multiple states, it gets to be a bit too much, actually, as they’ve all developed layers of rules, regulations, and reporting requirements that vary state-to-state. But knowing the basics and reading as much as you can is your best bet for staying compliant.
Putting it all to work
Now that you’ve read far too much on trust accounting, and after you have checked your local rules, what do you do next? Put this information to work for trust accounting in your own firm:
- Set clear trust accounting policies. Make sure your office policies for trust accounting are clearly spelled out so that a helpful assistant does not accidentally commingle funds or commit some other clerical error.
- Set up systems to guard against error. Do the simple stuff, like using different colored checks, to keep your name off the disciplinary list.
- Get a little help from technology. Ditch the Excel spreadsheet or paper ledger and use some of the many available tools—like Clio Manage and/or Quickbooks—to track your transactions and reconcile your records with your bank statements regularly.
It may seem like a lot to handle, but nobody ever said entrepreneurship and shingle-hanging were easy. With trust accounting, like all things, once you put good habits into practice, they become second-nature over time.
Note: The information in this article applies only to US practices. This post is provided for informational purposes only. It does not constitute legal, business, or accounting advice.
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