Running a law firm can be full of challenges, and accurate accounting practices is a vital part of that.
Regardless of the size, your firm’s reputation amongst clients and colleagues is directly affected by how the practice is managed. Not only that, but mismanagement can cause legal troubles that may result in fines for the firm and/or attorneys that are employed there.
Mismanagement could even result in disbarment if the charges are substantial enough.
One of the most complicated areas of law firm accounting has to do with the way in which client funds are handled. Often referred to as a retainer, how you manage these funds is going to be an important part of your overall accounting process.
What is a Retainer?
Often when an attorney takes on a new client, they are asked to pay a retainer before any work is done.
Retainers are payments that are based on a fee agreement between an attorney and a client. These fees can vary, depending on the assumed size of the case and the attorney’s hourly rate. When the case is finished and the client no longer needs the services of the attorney, any money that remains from the original retainer will be given back to the client.
How are Client Funds Held?
Because of the sensitive nature of holding client funds, it’s imperative that a law firm understand how these funds must be held and managed.
Law firms have to follow strict rules around how their client funds are going to be handled, where the client funds will be kept, and when those funds can be used.
While the exact rules are different from state to state, all lawyers are required to keep their client funds in client trust accounts that are separate from any of their operating accounts.
It is absolutely essential that a client’s retained money never be placed into an account that is used to pay operating expenses until after services are rendered. Doing so can bring significant consequences to a law firm.
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Therefore, in order to ensure that retained client funds are never used for operating expenses, they need to be placed in a trust account that is separate from any operating accounts. These client trust accounts are referred to as IOLTA accounts and must be managed in accordance with each state’s rules and regulations that govern them.
What is an IOLTA Account?
An IOLTA account is a client trust account that is set up through a financial institution to keep client funds until they are used to pay for work done by an attorney or law firm.
IOLTA stands for Interest on Lawyer Trust Accounts and is the acronym most widely used for these types of accounts across all fifty states.
These types of accounts will be used to deposit anything that is considered client money, from retainers to settlement checks. An IOLTA account ensures that the client’s money is kept separate from any of your firm’s business accounts or any of your attorney’s personal accounts. While it shares many similarities with escrow accounts, there are still some differences to understand about IOLTA account vs escrow account.
In some instances, a client’s funds may be substantial enough to warrant setting up a separate account just for that particular client. In a situation like this one, any interest that is earned on that client trust account will be distributed back to that client.
That said, it is more common for client funds to not be sizeable enough to justify opening an account just on their behalf. There are also many situations where the money won’t be held long enough to justify opening an account as well.
In these cases, a client’s funds will be deposited into a firm’s IOLTA account along with other client funds. Careful accounting must be practiced to ensure that each client’s money is accounted for appropriately.
What Happens to the Interest Generated by an IOLTA Account?
In the early 1980s, IOLTA accounts were created in order to give lawyers a way to pool multiple smaller client payments and short-term client funds into a single, interest bearing trust account.
Before IOLTA accounts, law firms had to hold all of their short term client funds in special checking accounts that could not earn interest.
The net interest that is earned on an IOLTA account is not distributed back to the clients. Instead, that interest earned is used by states to help fund civil legal services throughout their communities or state.
Most state IOLTA programs are run by the state’s bar association and have their own set of trustees and administrators who oversee the IOLTA program and decide how the IOLTA account earned interest funds are best spent for their state.
Over the years, IOLTA programs in every state have been able to make a notable difference in the legal aid services of many of their underserved and low-income residents.
From establishing and funding legal aid offices, providing legal aid services, and distributing grants to non-profit organizations, the money deposited into each state’s IOLTA program has made a significant impact on the lives of many individuals in that state who may not have been able to afford legal counsel otherwise.
How Does Money from an IOLTA Account Get Transferred to a State’s IOLTA Program?
Knowing the rules and regulations that govern a state’s IOLTA program is important, but making sure that a firm follows them correctly is another challenge of its own.
As mentioned, failure to comply with a state’s IOLTA program can result in actions taken against a law firm or an attorney that may significantly impact their reputation in the community and/or impact their ability to continue to practice law.
Anyone who is tasked with the responsibility of managing a firm’s IOLTA account will need to know exactly how their state bar association has specified that interest earned on that account be transferred to the state’s IOLTA program.
Most state bar associations will have a list of reputable banking institutions who can help set up a firm’s IOLTA account. They will also have specific instructions as to how the interest earned from a firm’s IOLTA account needs to be moved into the state’s IOLTA program.
What’s the Best Way to Manage an IOLTA Account Appropriately?
For most firms, the management of an IOLTA account can be challenging. Because there tends to be considerable rules that must be followed in order for a firm to stay in compliance with their state’s IOLTA program, it can feel intimidating to make sure that everything is being done correctly.
This is where having the right legal accounting software can make a big difference for your firm.
LeanLaw is legal accounting software that has been created by and for legal professionals who know the importance of accurate accounting for all their accounts. They know that keeping detailed records of every trust account transaction is crucial for a firm’s reputation and success.
They also know that keeping those detailed records can be a tedious and time-consuming task…time that could be better served on other tasks.
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LeanLaw accounting software is true, cloud-based, native QuickBooks integration that will help your law firm stay in compliance with industry best practices and state bar standards while also automating the way your law practice manages client funds based on your state’s rules surrounding them.
By using a three-way reconciliation approach to your firm’s accounting process, you will never have to worry that funds are being utilized inappropriately.
And, because LeanLaw’s accounting software is always in sync with your firm’s bank accounts, trust accounts and QuickBooks Online, your weekly or monthly three-way reconciliation will feel effortless and you will trust that everything is done correctly.
If you’re ready to see what LeanLaw accounting software can do for your firm, reach out to schedule a demo today. Let us show you how good legal accounting can make a big difference in your firm’s efficiency!