Written by Willie Peacock, attorney
What is trust accounting? Essentially, it’s necessary to keep separate track of client funds given in trust, away from law firm operating funds.
The concept of trust accounting can be one of the most feared and mythologized by lawyers when it comes to running a law firm. And for a 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.
This article will take you through the basics of trust accounting for law firms.
What is trust accounting?
Trust accounting is keeping track of client funds that are held in trust. While each jurisdiction has its own requirements, the two main rules they have in common are:
- Funds in trust must not commingle with the firm’s funds
- The firm must maintain accurate and detailed records of the money coming in and out, and must use the client’s own money for their own matters.
The second rule above means that lawyers also need to keep a watchful eye on how much each client has in trust, as they cannot use one client’s money to cover expenses for another client.
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. It pays to know the basics of trust accounting.
What is a trust account?
We’ve explained what trust accounting is—but what is a trust account? There are two types. Trust accounts can be pooled (holding funds for more than one client) or separate (usually if it’s a larger sum of money or explicitly requested by the client).
Best practices for trust accounting
Trust accounting best practice #1: Have an account
Having a trust account to comply with legal trust accounting regulations might seem obvious, but many attorneys actually choose to forego having an account. However, in some jurisdictions, you can’t even practice without having a trust 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, law 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. Having these documents on hand 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 trust accounts. Avoiding using your trust accounts means less bar oversight, less accidents jeopardizing one’s license, and fewer fund transfers between accounts.
For example, an exemption in Missouri allows lawyers to forego their trust account for flat-fee services under $2,000.
In response to this, some attorneys keep their flat fee amount under $2,000. Others charge 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. The reasoning is if you don’t use your trust account, it’s easier not to violate trust accounting rules as mandated by your jurisdiction—even if it’s at the cost of cash flow.
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.
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 jurisdiction’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 clear that the lawyer’s office has been diligent about record keeping.
Putting it all to work
While trust accounting seems like a relatively straightforward concept, keeping track of client trusts can get complicated if you’re managing accounts for multiple clients. You need to be diligent and ensure that each account is tracked properly with a full paper trail of statements so you can ensure that no funds were accidentally used improperly.
A legal trust accounting tool like Clio that has safeguards in place to give you peace of mind over trust transactions will help your firm as you scale. As long as you’re careful, diligent, and regularly check your statements, legal trust accounting doesn’t have to be scary. Take the horror stories about others’ trust accounting fails as cautionary tales and use their learnings to inform your own trust accounting processes.
Tools to help with trust accounts
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. They produce an unfathomable amount of literature, CLEs, and seminars on trust accounts. Knowing the basics and reading as much as you can is your best bet for staying compliant.
Keep in mind that through Clio’s Bar Associations program, you may be eligible for an exclusive discount on Clio products. For more information, visit our Bar Associations page and select your bar association.
For more resources, be sure to check out our accounting hub.
Final notes on trust accounting
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; the latter actually integrates with Clio.
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.
Want to learn more about how cloud-based practice management software can help you manage your trust accounting? Check out our free guide on managing trust accounting with Clio and our free webinar on How Law Firms Use Clio.