Trust Accounting 101 for Law Firms

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.

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 not know the basics of trust accounting. 

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.

As for trust accounts themselves, 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).

Trust accounting best practice #1: Have an account

This may seem obvious, to have a trust account to comply with legal trust accounting regulations, 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, 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. 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, 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:

1. 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.
2. 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.
3. 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).
4. When a case ends, and all claims are settled, any remaining amount is refunded to the client.
5. 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.
6. 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.

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. Ultimately 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.