Though there may not be a definitive event that resulted in the creation of attorney trust accounts, their purpose remains the same: to protect clients' funds by separating them from a lawyer's business funds to ensure professional conduct.
To illustrate what a client trust account is, we can draw an analogy to a checking account. Everything that goes into and comes out of this “checking account” belongs to the client or is spent on their behalf — not a law firm’s. When clients pay things upfront, these funds are still considered “unearned” since lawyers have yet to complete the work. This “checking account” keeps a client's money safe and separate from a lawyer’s personal and operational funds.
Under no circumstances can the funds in the separate account be used by the law firm for their operations until they have been earned.
It's a lawyer's professional responsibility to manage these trust accounts with the utmost good faith since failing to stay in line with the law could put you at risk for disbarment. Unfortunately, it is not uncommon for lawyers to commingle funds improperly and get themselves into trouble. Considering the risk of losing everything you worked so hard for, it’s worth going over some of the best practices for trust accounting. This guide is intended to help refresh your memory on the basics of your professional responsibility with trust accounting, and best practices you should know.
Open an IOLTA Account (Interest on Lawyer Trust Account)
In some states it’s impossible to practice without having a trust account, so your first course of action is to open one. Keep in mind, however, that opening a separate checking account alone isn’t sufficient. When you open an attorney trust account, also known as an IOLTA account, it must be explicitly designated as such with your bank. Since not all financial institutions are familiar with trust accounts, it may not always be a straightforward process. Because IOLTA accounts are far less common than traditional checking accounts, not all bankers open them on a regular basis.
Furthermore, disciplinary Rule 9-102 states that client funds paid to a lawyer or law firm, other than advances for costs and expenses, must be deposited into identifiable bank accounts maintained in the state in which the law office is situated. In other words, you can’t open a trust account in New York if your law practice is in New Jersey.
Once you open the account, you may want to structure your unearned and earned fees in a way that leads to minimal use of said trust account. Some states have exemptions that don’t require lawyers to open a trust account should they charge a flat fee under a certain amount. However, the rules surrounding trust accounts can be nebulous at times because they vary state by state, which is why trust accounting can be such a malpractice risk. Despite the fact that every state has an IOLTA program, only 44 of them require lawyers to participate.
What Happens to The Interest?
There can be a considerable amount of money sitting in a trust account throughout the duration of handling client funds. Let’s suppose a client receives a large settlement during a case; it won’t go straight into their pockets. Instead, it will first go into the trust account so that the attorney can deduct fees, third-party claims, and expenses. Before IOLTA came about in the early 1980s, trust accounts were to be put into non-interest-bearing checking accounts since lawyers were not to benefit from their clients' money.
However, IOLTA, which stands for “interest on lawyer trust accounts” allowed lawyers to place funds into interest-bearing trust accounts. The accumulated interest is transferred to the state IOLTA board that funds state-funded activity like:
- Legal aid for low-income citizens
- Law school scholarships
- Free civil legal services
- Grants for non-profit organizations
- Public service program funding
- Administration of justice improvements
The Rules For Fees Paid in Advance: You’re Better Off Safe Than Sorry
It’s important that you know the rules regarding what a lawyer can and cannot do with fees paid in advance of legal fees. In some states, law firms may be permitted to deposit fees paid in advance into their business account, however, only under specific circumstances. Each state bar has different rules, so unless you are absolutely certain that it's permitted in your state to submit advance fees like retainers and flat fees into your personal account, you’re better off putting the funds in your attorney trust account.
Know The Consequences
Lawyers who fail to comply with the rules will risk facing sanctions, and in some cases, even disbarment. For this reason, it’s incumbent upon lawyers to know the consequences of failing to adhere to the rules regarding attorney trust accounts.
Common Reasons Lawyers Get into Trouble with Trust Accounts
Prematurely Withdrawing Funds
Until the funds are considered “earned” an attorney may not under any circumstances borrow funds from an IOLTA account. This may sound obvious but it’s not an uncommon scenario for lawyers with a cash flow issue to borrow from a trust account with the intention of “paying it back.” Borrowing money from an IOLTA is a no-no under any circumstances, even if paid back within five minutes, and not worth the penalties.
Reporting Trust Deposits as Income
For the sake of simplicity, some law firms report trust deposits as income in their legal accounting software. Remember, these funds are not yours, and doing so could disrupt your taxes, and lead to disciplinary action.
Not Keeping Client and Business Accounts Separate
Money in an attorney trust fund is designated for your client only. You may not under any circumstances pay for any operating expenses out of the account, even if they’re considered earned funds. You must first move the earned funds to your business account to pay for operating expenses.
Billing Clients for Payment Fees
If you’ve made the switch to e-payment from traditional paper checks, then you may not pass the payment fee to the trust account. Use an online payment merchant, that is in compliance with ABA and IOLTA guidelines since you may only charge your clients payment fees that are directly connected to their trust account. Be sure to brush up on lawyer billing ethics so you don’t run into any problems with your clients.
Use Industry-Specific Accounting Software
It's your responsibility to track each incoming and outgoing transaction with detailed notes, accounting for every single amount, no matter how small. At the end of every month, you are required to reconcile the account to ensure everything is accurate. This is known as a 3-point reconciliation.
Generic non-industry specific accounting software can be a headache to use for 3-point reconciliation, whereas legal-specific accounting software makes it easy to decipher your data by maintaining:
- Point 1 — The balance of the trust account
- Point 2 — The balance of your liability of the trust account
- Point 3 — Broken down balances client-by-client
You can also produce trust reports by matter, ensuring that your total balance is the same as your IOLTA account for the same time range, which may not be possible with traditional accounting software. If you are audited by the state bar, you’ll want to make sure you can produce your trust balances on the fly in an easy-to-read format on a matter-by-matter basis.
Most importantly, legal-specific accounting software takes the specific rules of trust accounting into consideration, making it easier to track, collect, and reconcile all funds in your client trust accounts, providing safeguards to guarantee that funds are considered earned before you withdraw them. The client intake process can be incredibly time-consuming, so it’s wise to utilize tools to make you and your client’s lives easier during the process.
Reduce Your Liability and Avoid Consequences by Complying with the Rules
Trust accounts come with plenty of rules that vary in each state. Step out of line with these rules, and you could find yourself severely reprimanded. So, if you’re just starting your law firm, or you’re afraid you may have mismanaged your trust account, call a professional accountant who specializes in IOLTA.
The business side of running a law firm can feel overwhelming at times. But with the right information under your belt, good habits, and powerful legal technology you can ensure that your law firm meets with success. Luckily, at Lawmatics, we are here for all of your legal client relationship management needs. Automate your law firm and work smarter, not harder — welcome to the future of legal technology.
American Bar Association, ABA Model Rules on Client Trust Account Records - Rule 1 Recordingkeeping Generally, Americanbar.org https://www.americanbar.org/groups/professional_responsibility/resources/client_protection/aba-model-rules-on-client-trust-account-records---rule-1/
National Association of IOLTA Programs, IOLTA HISTORY, iolta.org/ http://iolta.org/what-is-iolta/iolta-history/
American Bar Association, TYPES OF IOLTA PROGRAMS, americanbar.org/ https://www.americanbar.org/ls_iolta_status_of_iolta_programs_11_14.authcheckdam.pdf