How to Handle Trust (IOLTA) Accounting Correctly in Your Law Firm
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One of the most stressful parts of bookkeeping for a law firm is trust accounting. Lawyers definitely did not go to college to become a bookkeeper, yet maintaining accurate IOLTA accounting is amongst the most ethical responsibilities for a law firm. Errors can lead to violations, disciplinary action or in the worst case, disbarment.
With the right systems in place, you can overcome these challenges. This blog serves as a guide to law firms experiencing difficulties in handling trust accounts. We will break down how to handle trust accounting for lawyers, what IOLTA accounting errors you need to be careful of and the major IOLTA compliance requirements for law firms needed to protect both your practice and your clients.
What is an IOLTA Account
Interest on Lawyers Trust Account (IOLTA) is a special account where law firms hold funds that do not belong to the firm. These may belong to clients or third parties. Such funds may be:
- Settlement funds
- Retainers
- Court costs paid in advance
- Guardianship
- Escrow deposits
Lawyers should never pool client funds with their own. The interest earned on such funds are automatically deposited to the state’s IOLTA program to fund public legal services. This means that such funds must be handled with a high level of care.
Why Trust Accounting Can Be Difficult For Lawyers
Some lawyers can struggle with trust accounting because:
- No margin of error: The tiniest error in recording transactions can lead to inaccurate balances or overdrafts.
- State to State laws: Your bar association dictates how you record transactions, manage reconciliations and disburse funds.
- Stricter Guidelines: Trust accounting guidelines are much stricter than normal business accounting.
- Insufficient Accounting Tools: General bookkeeping software may not meet IOLTA compliance requirements.
Common Trust Accounting Mistakes in Law Firms
IOLTA accounting errors can be committed by even the most experienced attorneys. Some of the common IOLTA accounting errors are:
- Failure to reconcile regularly: Trust account reconciliation for law firms must be done monthly and is a requirement of every state. Many law firms forget to reconcile individual client accounts or only reconcile bank balances. Reconciliation must match the trust account bank statement, individual client trust ledgers, and the checkbook register. Failure to balance all three accounts means that a compliance issue exists. Rounding off figures or skipping entries can cause major problems.
- Not keeping a clear paper trail: Every transaction must be properly documented. Law firms must have the paper trail such as deposit slips, check copies, receipts and disbursement records.
- Commingling Funds: Maintaining the same accounts for business purpose and trust accounts can lead to compliance issues. Depositing retainers into the business account, using trust funds for firm expenses or leaving earned fees in the trust account for longer than required are all seen as commingling of funds.
- Withdrawing Unearned Fees: Funds can be transferred from the trust account to the operating account only after the work is completed and invoiced. Premature withdrawals are violations even if you believe these funds have been earned.
- Lack of Understanding of State-Specific Requirements: Some states have additional requirements than other states and knowledge of these laws are mandatory to avoid penalties. For example, some states may require a minimum of 5 years of record retention, yearly trust account certifications or automatic overdraft reporting.
How to Handle Trust Accounting for Lawyers the Right Way
Let’s discuss some practical steps your firm can take to create a compliant trust accounting system:
- Clear Internal Policies: Some steps to create consistency across your team and reduce misunderstandings are listed below:
- Write down how funds are received and when the deposits were made
- Who is authorized to access the trust account
- How often reconciliations need to be done
- What documentation is required when withdrawals are needed to be made
- Segregation of Duties: One person could deposit the checks, another could record the entry while a third can perform the reconciliations. A solo practitioner could make use of a CPA or an experienced bookkeeper. Avoid allowing the same person to write checks and reconcile the accounts.
- Legal Accounting Software: Most standard accounting programs like QuickBooks alone are not built for trust accounting. They may not be sufficient for IOLTA compliance requirements for law firms as they may not be able to block negative client balances, prevent transfers of unearned funds or generating three-way reconciliations as discussed above. Consider using software specifically designed for law firms such as Clio Manage + Clio Accounting tools or PracticePanther.
- Deposit Funds Without Delay: Delays in depositing trust funds can lead to lost checks or commingling. It is good practice to deposit funds the same day, include a deposit slip and record the deposit in the client ledger simultaneously.
- Carefully Record Every Transaction: Every client specific transaction and matter should be immediately recorded to ensure client funds are not used for another’s matter, balances remain accurate and reconciliations are easier.
- Transfer Earned Fees Properly: Once fees are earned, generate an invoice, transfer the amount from trust to operating and record the transactions in both accounts. Never take funds from the trust account before issuing an invoice, without documentation and without a corresponding deduction in the client ledger.
- Document Everything: The bar may ask you to provide records of the following:
- Copies of checks
- Disbursement receipts
- Wire transfer confirmations
- Retainer agreements
- Reconciliation reports
Unable to produce the requested documents simply means it never happened.
- Monthly Reconciliation: A three-way reconciliation is non-negotiable. This compares the bank balance, trust account ledger balance and sum of all client ledger balances. Any discrepancies need to be immediately investigated. Deviations could be due to dates incorrectly recorded, duplicate entries or incorrect treatment of voided checks.
- Schedule Regular Internal Audits: Consider scheduling a quarterly internal audit or an annual audit with a CPA to catch problems early on.
- Clear Internal Policies: Some steps to create consistency across your team and reduce misunderstandings are listed below:
How to Avoid Trust Accounting Violations
Here are the best ways to stay compliant:
- Never Shortcut Procedures Even When Time is Short
- Review Trust Reports Every Week: Be vigilant for negative balances, old checks, old retainers or pending disbursements.
- Use Credit Card Payments or eChecks to Reduce Manual Entry
- Return Unused Balances as soon as possible
- Ensure Trust And Operating Funds Are Kept Separate
- Maintain Detailed Client Trust Ledgers
- Proper Documentation
- Use Funds Only for the Specific Matter The Funds Were Received For
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Why Proper Trust Accounting Protects Your Firm
Accurate trust account reconciliation for law firms is about more than ethical violations. It also:
- Builds Client Trust: Clients expect their money to be secure and responsibly handled.
- Reduces Stress: Simple IOLTA accounting errors can be the reason for disciplinary actions.
- Improves Cash Flow: Accurate tracking ensures earned money is received on time.
- Supports Your Reputation: Existing and potential clients often lose trust when they hear about any incident of mishandling of trust accounts.
Trust accounting doesn’t have to feel overwhelming. With solid procedures, the right legal accounting tools, and regular reconciliation, you can eliminate common mistakes and confidently meet IOLTA requirements.
When managed with care, consistency, and transparency, your trust account becomes a strength rather than a risk. By protecting client funds and following ethical guidelines, you reinforce your firm’s credibility and demonstrate the professionalism that clients and regulators expect.
