The stakes are high: trust account mismanagement is “one of the most frequent causes of [attorney] disciplinary action.” The compliance requirements are voluminous (and sometimes esoteric). With thoughtful planning and attention to detail, however, you can stay compliant.
Note: This article covers general trust accounting principles. The specific rules that apply to your trust accounts may be different, because trust accounting rules are set by states. Make sure to check your state’s rules and consult with ethics counsel as needed.
What is trust accounting?
The guiding principle of trust accounting is simple: Attorneys (and their staff) have a special duty to safeguard their clients’ money because attorneys are fiduciaries for their clients. As fiduciaries, attorneys must act in their clients’ best financial interest. That includes:
- Maintaining separate accounts for clients’ money (the trust account) and the firm’s money (the operational account).
- Making sure that the firm’s money is never commingled with clients’ money.
- Ensuring prompt notification/disbursement when the firm receives money for the client.
- Keeping detailed records of all transactions that involve client money.
- Reconciling trust accounts frequently to detect and correct errors.
The trust account holds clients’ money, like:
- Retainers and advanced fees.
- Escrow deposits for real estate transactions.
- Settlement funds and money awards.
- Other funds received on the client’s behalf.
If an attorney mismanages the trust account, even by accident, the consequences may be serious. Clients might lose trust in the firm. The firm might be liable for damages. Attorneys could face disciplinary action (public reprimand, fines, suspension, and disbarment).
Is a trust account the same as an IOLTA account?
Sometimes people refer to trust accounts as IOLTA (Interest on Lawyer Trust Account) accounts. Not every trust account is an IOLTA account. The type of trust account depends on the interest-earning potential of the client money held.
If the client would earn a minimal amount of interest (because the amount of money is small or it will not be held for long), it is pooled with other client funds in an IOLTA account. The combined funds earn interest, which is used to support legal aid and access to justice.
Larger amounts, or amounts held for a long time, are held in regular interest-bearing accounts (not IOLTA). The interest belongs to the client.
What are the most common trust accounting errors?
The rules for trust accounting are not always intuitive, and it is easy to make mistakes. Common errors include:
- Commingling client and firm funds
- Reconciling the trust account incorrectly or not frequently enough.
- Not tracking all the required information for each transaction
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6 principles for getting trust account right
Store client funds separately
This principle is simple, but it can be difficult to apply. Commingling examples include (but are not limited to):
- Using client funds to pay law firm expenses. Never pay firm expenses from the trust account, even if the money has been earned. Move it to the operating account first.
- Moving client money to the operating account before it has been earned. In most cases, retainer funds must be stored in the trust account until they are earned.
- Failing to move earned fees to the operating account regularly. This may seem counter-intuitive, but it is an example of storing the firm’s money in the trust account.
- Handling fixed fees improperly. There is significant variation among states on this issue. Some consider fixed fees to be earned upon receipt; others require lawyers to keep fixed fees in trust until earned.
Most states make an exception to the commingling prohibition for banking fees. In general, law firms may deposit their own funds in the trust account to pay for normal banking fees. Keeping a significant amount of firm funds in the trust account, however, may be a violation.
Keep thorough records
Trust accounting requires especially meticulous recordkeeping. The ABA Model Rules on Client Trust Account Records, Rule 1, provides a good overview of what is typically required:
- A journal of deposits and withdrawals from trust accounts
- A ledger for each client trust account
- Copies of retainer and compensation agreements
- Copies of any accountings to clients or third parties
- Copies of bills for legal fees and expenses
- Copies of records showing disbursements on behalf of clients
- Financial institution records like checkbook registers, bank statements, deposit records, cancelled checks, and substitute checks
- Detailed records of electronic transfers
- Copies of trial balances and reconciliations
- Copies of the parts of the client file that relate to trust accounting.
Note that ABA rules are advisory only in most cases, so you should refer to state law.
Communicate clearly
Keeping the client informed about their funds is part of the attorney’s fiduciary duty. It is also a good way to head off client misunderstandings that eat up your time and lead to disputes. Examples trust account communication include:
- The engagement letter or fee agreement, which should clearly state how money will move through the trust account.
- Statements, which should be sent regularly and should include a summary of the client’s trust account ledger. It is a best practice to send a statement whenever you pay earned fees from the trust account, even if no additional money is owed.
- Notifying the client when the attorney receives funds on their behalf. The funds must also be disbursed to the client within a reasonable period of time to avoid commingling.
Reconcile correctly and on time
Trust accounting requires three-way reconciliation. You must compare the bank statement against your trust ledger (two-way reconciliation) and also against each client’s trust ledger. All funds, down to the penny, must be accounted for.
Three-way reconciliations should be done on a regular schedule and frequently enough to catch errors promptly. Trust errors tend to snowball, so finding them early benefits everyone.
Many firms find it works best to reconcile monthly right before billing statement creation.
Write down procedures
Even if your accounting team is small, written procedures are essential for staying on track. Procedures should cover trust accounting workflows, checks and balances, and encourage prompt reporting of problems so any errors can be corrected swiftly. Procedures should be reviewed and updated regularly.
Know your state’s rules
It bears repeating—general trust accounting knowledge is necessary but not sufficient for trust account compliance. Stay up to date on your state’s rules and take advantage of local CLE resources.
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Tabs3 helps you get trust accounting right
Trust accounting is complicated. Tabs3 Financials can lighten your load.
- Instant communication with your bank, easy-to-read trust ledgers, and streamlined three-way reconciliation reports so you can reconcile faster.
- Flexible recordkeeping so you can store all the details needed for compliance.
- Dashboard summaries to help you spot trust problems early.
- Seamless integration with Tabs3 Billing and Tabs3Pay, an electronic payment solution built for lawyer trust account compliance.
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