Trust Accounting

Guide for Law Firm Best Practices

Law firm trust accounting is often presented as a complex maze, through which if you make the wrong turn, you will end up in legal purgatory or worse, lose your law license. It does not have to be this way.

On the flip side, law firm trust accounting can be the key to a profitable law practice. If you consistently maintain client funds in the trust account, you never have to chase a client for payment of legal fees. Invoicing payment for legal services can be a breeze.

Here’s the rub: until now, trust accounting software for law firms has been, if not nightmarish, then at the very least, inadequate. LeanLaw software, with its deep integration into QuickBooks Online, has created an elegant way to setup and manage trust accounts so that the legacy dread of disbursing trust funds evaporates, whether you are paying a client invoice or settling a case.

First, let’s get into the nitty gritty of trust accounting management in general.

What is Trust Accounting?

A law firm trust account is a bank account separate from the law firm funds, where client funds are kept that have not yet been earned by the law firm. The funds in the trust account include:

  • Client Retainers (money advanced by the client for future payment of legal fees and expenses)
  • Settlement Funds
  • Escrow funds
  • Advances on costs associated with the case

Many trust accounts are called IOLTA accounts. IOLTA stands for “Interest on Lawyers’ Trust Accounts.” (In some states (NY) they are IOLA – “Interest on Lawyer Account” or IOTA (FL) “Interest on Trust Account”)

The money is held in trust on behalf of the client until it is earned. It’s not the law firm’s money and therefore, needs to be managed in this separate account. Once fees are earned, an invoice is created and then paid from the client trust account. At that point, the money is transferred from the trust account to the firm operating account.

ABA (American Bar Association) rules of professional conduct outline the fiduciary responsibilities of the lawyer and vary by state. What is essential is detailed recordkeeping for every transaction — mishandling trust account funds can result in losing your law license. This is what turns off many law firms from accepting client retainers — that, and the complex bookkeeping that maintaining a trust account requires.

Trust funds not only ensure payment, but are an essential competency of managing accounts receivable.

When you bill your client, that’s when you transfer the funds from the trust to the law firm’s operating account. You can display the client trust account balance on the invoice to let them know where they stand. If you keep careful records and follow state bar rules, client trust accounts can exponentially decrease your accounts receivable meaning, your cash flow will increase.                                   

Most law firms secure all of their client’s retainer funds in one trust account. How you decide to setup your law practice’s trust account(s) will depend on:

  • The amount of money deposited by each client
  • The request of the client to keep it separate (varies by state)
  • Fiduciary decisions made on a case by case basis.

Law practices that service estate administration create a trust account for each individual client, a specialized area in that each client’s estate has a tax ID number and a separate bank account.

Because most firms hold all clients’ retainer funds in one trust account, it is crucial to be able to accurately identify each client’s individual portion. Not only is this important for 3-way reconciliation at the end of each month, but you’ll also need to provide the client an accurate accounting of their funds at any time. This is usually handled by creating sub-liabilities or ledgers for each client to appropriately track the movement of money into and money out of the account.

Legal Trust Accounting Compliance Checklist

Is Trust Accounting Difficult?

Trust accounting does not have to be difficult. The main difficulty arises out of the lack of bookkeeping and accounting best practices: is the data you’re looking at accurate in real time?

If you are looking at the trust account statement and the amount is say, $1000, but you don’t know that someone withdrew $50 over an hour ago, you’re not looking at real time data. This matters because at this point, your accounts are out of balance. Reconciling two views of the same account is not a modern way of dealing with law firm accounting.

It doesn’t have to be this way.

Legal Trust Accounting in QuickBooks Online – The Easy Way and the Hard Way

Three-Way Reconciliation

When looking for software to manage your law firm accounting and specifically IOLTA trust accounting, the most important feature to look for is three-way reconciliation between the financial institution and the accounting software so that you have the comfort of knowing that the data you are looking at is in sync and accurate in real-time and compliant to your state’s bar’s rules.

In LeanLaw, the three entities of this sync include:

  • Trust Account
  • Liability Account
  • Individual Client Trust Ledger

The combination of QuickBooks account reconciliation tools and LeanLaw’s trust accounting workflows streamline and automate the process and ensure accuracy. More on this at the end of the article.

What are the benefits of trust accounting?

The benefits of trust accounting far outweigh the perils. If you’re a lawyer, you are necessarily involved in the details of a matter.  Proper workflows and the right tools make trust accounting a valuable and manageable function in your law firm.

Trust Accounting Increases Cash Flow

If the funds are already in the client trust account, you don’t have to worry about when your client will pay you. Accounts receivable will collect 100% of the payment, 100% of the time. All you have to do is transfer the amount owed from the trust account to the operating account. You always know your work-in-process to trust funds availability ratio.  This ensures that you stay in alignment with what your client expects to pay.

1.  It decreases AR and ensures you don’t have to create terms or be a bank for your client.

2.  It keeps financial alignment between you and your client specific to the work being completed.

3. It creates consistency in cash flow.

The downside of law firm trust accounting is that trust account rules are strict: if you don’t manage the accounts properly and commingle funds, you could lose your law license. While that is a serious consequence, if you have a proper bookkeeping workflow for the trust account records in your law office, you won’t have this issue.

The other downside of trust accounting is if you don’t have modern, automated accounting software. Without three-way sync, you will be doing a lot of manual labor reconciling the accounts before you can balance them — not worth your time when there is software that can do all of this for you in just a few clicks.

How to Simplify IOLTA Trust Accounting – With LeanLaw

LeanLaw is the premier legal app in the QuickBooks Online app store. LeanLaw customizes QuickBooks Online for law firms. You get the robust accounting foundation that QuickBooks provides and then the LeanLaw app creates a more friendly user experience for the law office.

The lawyers and law staff work in LeanLaw while the accounting folks work in QuickBooks. Everyone sees the same data in real time.

The 3-way sync between QuickBooks, LeanLaw and the bank account is the secret sauce for the most elegant trust accounting software in the QuickBooks world. The real-time integrations make QuickBooks the source of truth: LeanLaw and the bank take their cues from QuickBooks. Since the sync is continuous, you don’t have to sync because you are already in sync.                                

If you can provide modern, easy-to-use software for your law practice, the lawyers and other timekeepers will use it more often and be grateful for the time savings. LeanLaw can provide profitability to your law practice by decreasing AR.And when the law staff uses software that delights them, it will boost morale. A happy work environment is a productive and profitable work environment.