This week’s post is a Q&A about law firm trust accounting with John Guzowski, CPA.
What are some of the basic concepts of law firm Trust Accounts?
IOLTA or Trust Accounts exist to keep track of funds that do not belong to a law firm at the time they are received. These funds can be gross settlements, deal proceeds, amounts owed to clients or third parties, or retainers that will be earned in the future.
Retainers are paid by a client before legal fees have been earned or expenses have been incurred. Some firms keep the retainer as a safety net and ask clients to pay their invoices in addition to the retainer where other firms apply the retainer to the invoices when they are prepared.
Gross settlements must be reviewed to determine clients’ portion, case costs to be reimbursed, third party advances to client, liens, unpaid medical bills, co-counsel fees, legal fees, etc. When this calculation is complete and the client has agreed to the amounts and signed the settlement statement, checks can be prepared and distributed. Once funds are disbursed, the case ledger balance within the Trust Account should be zero. Though sometimes funds are kept in the account for unknown future case expenses or an amount to reimburse Medicare.
In all cases, while the funds are in a law firm’s Trust Account, they do not belong to the firm, and the attorney responsible for the trust account has a fiduciary duty to ensure the accounting for those funds are accurate. Most Bar Rules require separate ledgers be kept for every case and that a monthly reconciliation be performed ensuring the balance of the entire Trust Account matches the bank balance and that every dollar is associated with a case. The only funds not associated with a case are interest earned on the account which is often transferred by the bank to a state bar.
What are some best practices to keep Trust Accounts accurate (and lawyers out of trouble)?
Trust accounting is not difficult, but it requires a commitment to extreme detail, constant reconciliation, and monthly reviews of lingering balances. Firms that strive to comply with the rules do the following:
- Keep a separate trust ledger for each case in their accounting system or case management system
- Prepare a check for every line item on the signed settlement statement
- Correct any mistakes immediately
- Prepare a 3-way reconciliation monthly (bank balance reconciles to general ledger which reconciles to all client trust ledgers)
- Review trust ledgers with balances monthly and determine if you have additional information that will allow payment of trust funds
What are some problems you’ve encountered when reviewing Trust Accounts?
Busy firms often don’t take the time to ensure the Trust Accounts are perfect. We have seen all the following situations which lead to inaccurate trust accounting:
- Bank reconciliations are prepared monthly, but no one matches the reconciled bank balance to the individual trust ledgers…if they exist
- A second or third Trust Account is opened with the intention of keeping it clean when an existing Trust Account can’t be reconciled
- There are trust ledgers with balances that are never reviewed
- In addition to having separate ledgers by client, there is a ledger for unidentified funds
- Trust disbursements are made on a case before settlement check is deposited into the Trust account
- Trust Account is used for working capital needs of the firm
- Credit card fees are deducted from the Trust Account
- Firm funds are deposited in Trust Account to help avoid any chance of over-draft
- Legal fees are left in Trust Account after all other funds are distributed in an attempt to defer taxes
What are some of the consequences of sloppy or inaccurate trust accounting?
If you follow best practices you will always know whose funds (and how much) you are holding in the Trust Account, you won’t put your law license at risk, and you will never have to pay for an expensive clean up project.
Not following best practices could result in:
- Violations of bar rules
- Co-mingling third party funds with firm funds
- Improper use of trust funds
- Sanctions or possible disbarment
- Expensive and time-consuming audit and clean up of trust accounting.
Any final thoughts?
Proper trust accounting needs to be a priority in line with keeping enough money in your operating account to make payroll. Failure to keep up with it puts everything you work for at risk. Even though attorneys have the ultimate responsibility for their Trust Accounts, they need to ensure someone is assigned the task of reconciling the Trust Account every month. This will protect their clients and their law practices.
John Guzowski is the owner of Abacus Advisors, which serves as an outsourced CFO, bookkeeping, and financial advisory consultant to law firms. You can find John at www.abacusadv.com, firstname.lastname@example.org, or at (404) 596-7463.