Key Takeaways:
• Yes, escrow accounts earn interest, but law firms cannot keep it—IOLTA interest goes to legal aid programs while individual account interest belongs to clients
• All 50 states have IOLTA programs that generated over $175 million in 2020 alone, funding civil legal aid for those who cannot afford representation
• The “nominal or short-term” test determines whether funds go into pooled IOLTA accounts or individual interest-bearing accounts, with attorneys making this critical determination
Here’s a $175 million question that confuses even experienced attorneys: Does your escrow account earn interest? The answer might surprise you—and the implications definitely will.
Last year, a mid-sized firm in Texas discovered they’d been placing large, long-term settlement funds in their IOLTA account for years. The problem? Those funds should have been earning interest for their clients in individual accounts. The result was an ethics investigation, mandatory remedial education, and some very uncomfortable client conversations about thousands of dollars in lost interest.
The confusion is understandable. Law firms juggle multiple types of trust accounts, each with different interest rules, beneficiaries, and compliance requirements. Add in state-specific variations, changing interest rates, and evolving banking regulations, and you’ve got a recipe for honest mistakes that can lead to serious consequences.
But here’s what every law firm needs to understand: Yes, escrow accounts absolutely earn interest. The critical questions are: Who gets that interest? When should you use which type of account? And how do you stay compliant while maximizing benefits for all parties involved?
The Short Answer: Yes, But It’s Not Yours
Let’s cut through the confusion with a simple truth: Escrow accounts do earn interest, but that interest never belongs to your law firm. This fundamental principle underlies all trust account management and stems from the ethical prohibition against attorneys profiting from client funds.
Here’s how it breaks down:
IOLTA Accounts (Pooled Trust Accounts):
- Earn interest? Yes
- Who gets it? State bar foundations for legal aid programs
- Your benefit? Zero (and that’s by design)
Individual Client Escrow Accounts:
- Earn interest? Yes
- Who gets it? The client
- Your benefit? Zero (and you can’t charge for managing it)
Your Operating Account:
- Earn interest? Possibly
- Who gets it? Your firm
- The rule? Never mix with client funds
This prohibition isn’t just an ethical guideline—it’s a foundational principle that protects both clients and attorneys. As one expert notes, “unearned money held in an IOLTA account cannot be used for operating expenses or a lawyer’s personal expenses.”
The Birth of IOLTA: Turning Prohibition Into Purpose
Before 1981, this interest prohibition created an ironic situation. Client funds sat in non-interest-bearing accounts, benefiting no one. Then Florida pioneered a brilliant solution: What if those small amounts could earn interest for charitable purposes?
The concept spread like wildfire. Following federal banking law changes in 1980 that allowed interest-bearing checking accounts, every state eventually adopted IOLTA programs. Today, these programs represent one of the legal profession’s greatest contributions to access to justice.
The numbers tell the story:
- Since 1981: Over $4 billion generated nationwide
- 2020 alone: $175 million in IOLTA grants
- 2025 milestone: Idaho distributed a record $600,000 in one year
This interest hasn’t just disappeared into the ether—it’s funded legal aid offices, pro bono programs, and law-related public education that serves millions of Americans who couldn’t otherwise afford legal help.
Understanding How IOLTA Interest Works
IOLTA stands for “Interest on Lawyers’ Trust Accounts,” and understanding how these accounts generate and distribute interest is crucial for every law firm.
The IOLTA Interest Pipeline
Here’s the journey of every dollar of IOLTA interest:
- Client Deposits: Multiple clients’ funds are pooled in one IOLTA account
- Interest Accrues: The bank calculates interest on the total balance
- Automatic Remittance: Banks send interest directly to state IOLTA programs
- Grant Distribution: State programs fund legal aid organizations
- Community Impact: Low-income individuals receive free legal services
You never touch the interest—it flows automatically from bank to bar foundation. This automation is intentional, removing any temptation or complication for law firms.
What Makes Funds “IOLTA-Eligible”?
The key question every attorney must answer: Should these funds go into IOLTA or an individual account? The test is whether funds are:
“Nominal in amount”: Generally interpreted as funds too small to earn meaningful interest after accounting for:
- Bank fees and service charges
- Administrative costs
- Tax reporting requirements
- The cost of establishing separate accounts
“Held for a short period”: Typically funds held for:
- Less than 60-90 days
- Routine real estate closings
- Small retainers being quickly earned
- Court costs and filing fees
The beauty—and challenge—of this system is that attorneys make this determination. There’s no universal dollar threshold or time limit. You must consider current interest rates, bank fees, and administrative costs to make an informed decision.
State Variations: The Devil in the Details
While all 50 states have IOLTA programs, the details vary significantly:
Mandatory vs. Voluntary:
- Most states: Mandatory participation
- Some states: Voluntary but strongly encouraged
- All states: Require IOLTA for qualifying funds if you participate
Interest Rate Requirements:
- Some states mandate “highest available rates”
- Others allow “comparable to similar accounts”
- Many have preferred “Platinum Partner” banks offering better rates
Reporting Obligations:
- Annual compliance certificates
- Account registration requirements
- Change notification procedures
For example, New York requires every lawyer handling client funds to maintain an “IOLA” account (their term for IOLTA), while some states provide more flexibility in account structure.
When Clients Keep the Interest: Individual Escrow Accounts
Not all client funds belong in IOLTA. When funds are substantial enough or held long enough to generate meaningful interest, that interest belongs to the client. This is where individual escrow accounts come into play.
The Individual Account Triggers
Consider opening an individual interest-bearing account when:
Large Sums:
- Major settlement proceeds ($100,000+)
- Real estate transaction funds held for extended periods
- Estate distributions awaiting probate resolution
- Class action settlement funds
Extended Duration:
- Funds held pending appeal
- Minor’s funds until age of majority
- Structured settlement implementations
- Complex transaction escrows
Client-Specific Situations:
- Client specifically requests interest
- Institutional clients with interest policies
- Funds earning enough to justify 1099-INT reporting
The Math Behind the Decision
Let’s make this concrete with an example:
Scenario A – IOLTA Appropriate:
- Amount: $5,000 retainer
- Expected duration: 45 days
- Current interest rate: 4.5% annually
- Potential interest: ~$28
- Bank fees: $25/month
- Net benefit to client: Negative
Scenario B – Individual Account Required:
- Amount: $250,000 settlement
- Expected duration: 6 months
- Current interest rate: 4.5% annually
- Potential interest: ~$5,625
- Bank fees: $25/month
- Net benefit to client: $5,475
The difference is clear, but many situations fall in gray areas requiring professional judgment.
Client Communication Requirements
When using individual interest-bearing accounts:
Disclosure Obligations:
- Inform clients about interest accrual
- Explain any fees or charges
- Clarify tax responsibilities
- Document client consent
Ongoing Responsibilities:
- Provide periodic statements showing interest earned
- Issue 1099-INT forms when required
- Maintain detailed records for client and tax purposes
- Never charge for interest management time
Remember: The interest belongs entirely to the client. You cannot charge administrative fees or take any portion as compensation for managing these accounts.
The Decision Framework: Navigating the IOLTA Maze
Making the right account decision requires a systematic approach. Here’s a framework successful firms use:
Step 1: Initial Assessment
Ask these threshold questions:
- Is this client money? (If yes, continue)
- Is it earned or unearned? (If unearned, continue)
- Will we hold it more than momentarily? (If yes, continue)
Step 2: The Nominal/Short-Term Analysis
Consider these factors:
Amount Analysis:
- Under $1,000: Almost always IOLTA
- $1,000-$10,000: Consider duration and rates
- $10,000-$50,000: Careful analysis required
- Over $50,000: Lean toward individual account
Duration Analysis:
- Under 30 days: Generally IOLTA
- 30-90 days: Consider amount and rates
- 90-180 days: Often individual account
- Over 180 days: Almost always individual
Current Economic Factors:
- Interest rates (higher rates favor individual accounts)
- Bank fees (higher fees favor IOLTA)
- Administrative burden (complexity favors IOLTA)
Step 3: Document Your Decision
Whatever you decide, document your reasoning:
- Date of determination
- Factors considered
- Interest rate environment
- Expected duration
- Mathematical calculations
- Final decision and rationale
This documentation protects you if questioned later about your judgment.
Common Scenarios and Solutions
Real Estate Closings:
- Standard residential: IOLTA (usually 30-45 days)
- Commercial with delays: Consider individual account
- Failed transaction funds: Reassess based on new timeline
Litigation Retainers:
- Simple matters: IOLTA
- Complex litigation: Consider expected duration
- Appeal bonds: Often individual account
Settlement Proceeds:
- Quick disbursement: IOLTA
- Structured settlements: Individual account
- Minor settlements: Individual account until majority
Estate Matters:
- Simple estates: Often IOLTA
- Complex estates: Individual accounts by beneficiary
- Disputed estates: Individual preservation accounts
Interest Rates and the Economic Reality
The current interest rate environment significantly impacts trust account decisions. After years of near-zero rates, recent changes have revived the importance of interest considerations.
The Changing Landscape
Historical Context:
- 2010-2020: Near-zero rates made most interest negligible
- 2021-2023: Rising rates increased interest potential
- 2024-2025: Higher rates making individual accounts more attractive
Current Implications: With rates above 4%, even moderate balances can generate meaningful interest:
- $25,000 for 60 days at 4.5% = ~$185
- $50,000 for 90 days at 4.5% = ~$556
- $100,000 for 120 days at 4.5% = ~$1,480
These amounts now exceed administrative costs, tipping more funds toward individual accounts.
Banking Relationships Matter
Not all IOLTA accounts are created equal. Interest rates vary dramatically:
Platinum Partner Banks: States often negotiate preferred rates with banks offering:
- Higher interest rates (sometimes 70-80% of money market rates)
- Waived monthly fees
- Simplified IOLTA reporting
- Better online banking tools
Standard IOLTA Rates: Regular banks might offer:
- Minimal interest rates (0.01-0.10%)
- Monthly service charges
- Basic reporting
The difference can be substantial. On a $100,000 average balance, the annual difference between 0.10% and 3.5% interest is $3,400 in funding for legal aid—reason enough to shop around.
Negotiating Better Terms
Your firm has leverage:
- Multiple account relationships
- Total deposit balances
- Long-term banking history
- Competition among banks for IOLTA business
Use it to negotiate:
- Higher IOLTA interest rates
- Waived fees on all trust accounts
- Free business services
- Better technology integration
Remember: Higher IOLTA rates don’t benefit you directly, but they demonstrate your commitment to the legal aid community and can enhance your firm’s reputation.
Compliance Landmines: What Not to Do with Interest
Understanding what you cannot do with trust account interest is just as important as knowing the rules. Here are the violations that keep bar disciplinarians busy:
The Cardinal Sins
1. Borrowing Against Future Interest Even if you “know” interest will accrue, you cannot:
- Use expected interest as collateral
- Advance funds against future interest
- “Borrow” interest to be “replaced later”
2. The Administrative Fee Trap You cannot charge clients for:
- Time spent managing interest-bearing accounts
- Calculating and reporting interest
- Preparing tax documents
- Any “administration” of their interest
3. The Savings Account Misconception Some firms try to use IOLTA as a high-yield savings account by:
- Leaving earned fees in IOLTA
- Depositing firm funds “temporarily”
- Using IOLTA for cash flow management
This is strictly prohibited and easily detected during audits.
Record-Keeping Requirements
Interest adds complexity to trust accounting:
For IOLTA Accounts:
- Monthly bank statements showing interest paid to state
- Annual IOLTA compliance certificates
- Registration confirmations
- Bank designation letters
For Individual Accounts:
- Separate ledgers showing interest accrual
- Client notification documentation
- 1099-INT preparation records
- Written authorization for account opening
For Both:
- Clear documentation of account type decisions
- Interest calculation worksheets
- Client communication records
- Five to seven-year retention (varies by state)
Tax Implications and Reporting
The tax treatment varies by account type:
IOLTA Interest:
- Not taxable to attorney or client
- Bank reports directly to state bar TIN
- No 1099 issued to firm or client
- No tax obligations for anyone
Individual Account Interest:
- Taxable to the client
- Requires 1099-INT if over $10
- Client’s SSN or TIN required
- Year-end reporting obligations
Common Tax Mistakes:
- Using firm’s TIN for client interest
- Failing to issue 1099s
- Not collecting client tax information
- Misreporting interest on firm returns
Best Practices for Mastering Interest Management
Leading firms have developed systems that make interest management routine rather than risky:
1. Standardized Decision Trees
Create written policies addressing:
- Dollar thresholds for account types
- Time thresholds for account types
- Who makes account decisions
- Documentation requirements
- Review and update procedures
2. Intake Procedures
At client onboarding:
- Collect tax ID information
- Discuss potential interest scenarios
- Get written authorization for account types
- Explain interest ownership clearly
3. Banking Relationships
Optimize your banking:
- Use Platinum Partner banks when available
- Negotiate fee waivers
- Set up separate online access for trust accounts
- Automate interest reporting where possible
4. Monthly Procedures
Establish routines for:
- Reviewing all interest-bearing accounts
- Confirming proper interest disposition
- Reconciling interest payments
- Updating client ledgers
5. Client Communications
Keep clients informed:
- Send quarterly interest statements
- Provide year-end summaries
- Issue tax documents timely
- Document all communications
6. Training and Updates
Ensure your team knows:
- Current interest rates and thresholds
- State-specific requirements
- Proper documentation procedures
- Red flags to identify
Technology Solutions: Automating Interest Compliance
Manual interest tracking invites errors. Modern legal accounting software transforms this challenge:
Automation Benefits
Interest Calculation:
- Automatic daily calculations
- Accurate penny rounding
- Multiple rate handling
- Clear audit trails
Decision Support:
- Built-in nominal/short-term analysis
- Rate comparison tools
- Threshold alerts
- Documentation templates
Compliance Tracking:
- Automatic IOLTA registration reminders
- Interest payment verification
- 1099 preparation tools
- State-specific rule updates
Integration Features:
- Bank feed connections
- QuickBooks synchronization
- Client portal access
- Automated reporting
Selecting Technology
Look for software that:
- Understands both IOLTA and individual accounts
- Automates interest calculations
- Generates required reports
- Maintains audit trails
- Updates for regulation changes
The right technology transforms interest management from a compliance burden into a competitive advantage—demonstrating your firm’s sophistication and commitment to proper trust accounting.
Your Path Forward: Interest With Integrity
The question isn’t whether escrow accounts earn interest—they absolutely do. The real questions are: Are you directing that interest properly? Are you making optimal decisions for your clients? Are you maintaining bulletproof documentation?
In a world where IOLTA programs have generated over $4 billion for legal aid, where interest rates are making individual accounts attractive again, and where trust account violations can end careers, you can’t afford to guess about interest handling.
Here’s your action plan:
- Audit your current accounts: Are all funds in the right type of account?
- Review your policies: Do they reflect current rates and regulations?
- Upgrade your systems: Can they handle interest tracking automatically?
- Train your team: Does everyone understand the rules and procedures?
- Document everything: Can you defend every account decision?
The stakes are too high for manual processes and outdated approaches. Every day you operate without clear interest policies and automated systems is another day courting disaster—or at least missing opportunities to better serve your clients and community.
Ready to transform your trust account management from a compliance headache into a streamlined system? Discover how LeanLaw’s trust accounting features automatically handle interest calculations, account classifications, and compliance reporting. Schedule a demo today and join forward-thinking firms that have eliminated interest-related compliance risks while maximizing benefits for clients and legal aid programs alike.
Frequently Asked Questions
Do all escrow accounts earn interest?
Yes, in today’s banking environment, virtually all escrow accounts can earn interest. IOLTA accounts pool client funds to earn interest for legal aid programs, while individual client trust accounts earn interest for specific clients. The key distinction is who receives the interest, not whether interest is earned.
Can my law firm keep any interest from client funds?
No, absolutely not. Attorneys cannot profit from interest on client funds under any circumstances. IOLTA interest goes to state bar foundations for legal aid, while individual account interest belongs entirely to the client. This prohibition is fundamental to legal ethics.
How do I determine if funds should go in IOLTA or an individual account?
Consider whether the funds are “nominal in amount or held for a short period.” Generally, amounts under $5,000 held less than 60 days go in IOLTA. Larger amounts or longer durations may warrant individual accounts. Calculate potential interest minus bank fees—if the client would receive net benefit, use an individual account.
What happens if I put funds in the wrong type of account?
Mistakes happen, but they must be corrected immediately upon discovery. If IOLTA funds should have earned client interest, calculate and pay the lost interest to the client. If individual account funds went to IOLTA, document the error and reasoning. Either way, disclose to the client and document thoroughly.
Do I need to give clients 1099s for interest earned?
Yes, if a client earns more than $10 in interest from an individual trust account, you must issue a 1099-INT. This requires collecting the client’s taxpayer identification number at intake. IOLTA interest doesn’t require 1099s since it goes directly to the state bar foundation.
Are there different rules for real estate escrows vs. litigation funds?
The basic rules are the same—nominal or short-term funds use IOLTA, while substantial or long-term funds need individual accounts. However, real estate transactions often have specific escrow requirements under state law that may override normal IOLTA rules. Always check both legal ethics rules and real estate regulations in your jurisdiction.
