What is trust accounting? Essentially, it’s the need to keep separate track of client funds given in trust, away from law firm operating funds. In my opinion, it seems that the concept is one of the most feared and mythologized by lawyers when it comes to running a small firm.
And for good reason. Practice for a few years and you’ll undoubtedly hear horror stories of that one attorney who made a mistake—just that one time—and lost their ability 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, you’ll likely encounter 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 cost you your license.
This article will take you through the basics of everything you need to know about trust accounting for law firms. This includes the process of opening a trust account, and best practices you need to know about trust accounting in order to ensure you and your law firm abide by the law.
Trust accounting best practice #1: Have an account
In some states, you can’t even practice without having an account. Even if it’s for pro bono work. It’s common for law firms to operate one or more pooled trust accounts depending on the nature and needs of the practice. For example, firms that handle real estate matters may require several pooled trust accounts at different financial institutions. On the other hand, a criminal practice may require only one pooled trust account.
When setting up a new trust account, ask your financial institution to provide trust account statements at the end of the reporting period. This will ensure that the financial institution reports all activities and balances in your trust account at month-end and year-end dates. This will be useful for trust reconciliations and annual Trust Report requirements.
Trust accounting best practice #2: Use the trust account 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, a new exemption in Missouri allows lawyers to forego their trust account for flat-fee services under $2,000. In response to this, some attorneys have decided to keep their flat fee amount under $2,000. Others are charging an “intake fee” at the start of the case and the remainder of the flat fee is kept under $2,000 in order to be exempt.
It’s unclear whether or not charging such an “intake fee” does not count as part of this limit. This is exactly the sort of murky trust account question that keeps lawyers up at night, by the way.
The trust accounting process
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 record keeping.
Opening a trust account
When first starting out, I was advised to open my operating account and trust account at different banks. This way I would never confuse the two and accidentally deposit client funds into my operating account.
There are two big issues with this advice. First, it requires having 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 balances are often low and they can’t charge any additional, surprise fees. This means many banks simply won’t take your business.
An easier solution is to simply get different-colored checks for your trust account and operating account. Have “trust account” written in a very noticeable font on the trust checks.
Attorney trust accounting rules when practicing in multiple states
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? Well, it’s 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. Only two of those states, Missouri and North, 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 personally happened to me at 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 the bank and call your state’s trust accounting phone line, if they have one, to make sure you are setting things up the right way.
IOLTA, IOLA, or Attorney Trust? What’s the difference?
All of these types of accounts (IOLTA, IOLA and Attorney Trust) have the same purpose. They all segregate client funds from your typical business or operating account. The difference is simply in the interest—how much accumulates and who gets it. No matter what it 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 convert it to an IOLTA account.
Difference between trust and operating accounts
At the very basic level, a trust account is for client funds only. The operating account is the law firm’s money. Period.
However, 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. In other states, any fees are required 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 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. Then, you 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—for example, your typical personal injury settlement—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 will 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 it. 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. As a result they commingle 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 commingling of funds. 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 cautionary trust account tale
Think that getting involved in trust accounting mishaps won’t happen to you? A friend of mine fell into the second bucket described above. 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. She also had to 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, there’s no need to 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, 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. They will not surprise you by charging fees or clawing back funds from your client trust account.
Other vendor options for processing credit card payments may not be so easy and convenient to use. For example, when I started out, I used a Square reader on my smartphone. This is 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. They didn’t have an option to charge fees to a separate account.
Of course, you’ll still have to watch your ledgers. And you’ll need to reconcile your trust account regularly, as you would with checks and cash. But today, 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 has a free version. It does not integrate with Clio but it did allow me to pull my bank account ledgers directly from the banks’ website. 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 trust accounts. This is because managing trust accounts is a common ethics issue. If you are like me and licensed in multiple states, it gets to be a bit too much. 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
After you’ve read more about trust accounting and checked your local rules, what do you do next? Well, you can start by applying this information to how you address trust accounting in your own firm. Below are a few pointers:
- Set clear trust accounting policies. Clearly spell out your office policies for trust accounting. This will ensure 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. Use some of the many available tools to regularly track your transactions and reconcile records with bank statements. Options include Clio Manage and/or Quickbooks.
It may seem like a lot to handle, but nobody ever said entrepreneurship was going to be 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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