3 Trust Account Mistakes That Lawyers Make and How to Avoid Them (2022)

Trust Account Mistakes That Lawyers Often Make

3 Trust Account Mistakes That Lawyers Make and How to Avoid Them (1)

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William Pfeifer

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William L. Pfeifer, Jr., is a former writer for The Balance Small Business and an attorney who has written extensively on legal issues and the practice of law.

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Updated on December 03, 2019

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Mismanaging a trust account can have terrible consequences for a lawyer's career, sometimes even to the point of disbarment. Law schools do an abysmal job of training law students on how to handle Interest on Lawyer Trust Accounts (IOLTAs). Most attorneys receive little or no training on how to manage a trust account before opening one of their own.

How an IOLTA Account Works

Attorneys often receive retainer fees from clients when they mutually sign a retainer agreement that outlines the terms of the attorney's representation. That money is supposed to go into the lawyer's trust account. They're then entitled to pay that money out to themselves as they complete work for the client.

They might agree to represent Harry in a nasty divorce. Harry writes them a check for $10,000 retainer fee. The attorney deposits the money into their trust account, then spends an hour working on their new client's file. The attorney's hourly rate is $150. The attorney is then entitled to move $150 of that $10,000 from the trust account into his business account. They've earned it.

Meanwhile, $9,850 remains in the IOLTA account, and it's earning interest. That interest goes to fund a variety of legal services, typically for the poor, under the management and oversight of the IOLTA program.

Lawyers tend to make three common mistakes lawyers in managing these accounts.

"Borrowing" Money From the Account

There is no legitimate way to borrow from a trust account, but some attorneys try.

Sometimes attorneys use trust account funds before they have a right to do so. They might take trust account money before it's earned because they're having cash flow problems. They might not have completed billable work before some looming expense must be paid — payroll, office rent, or costs being advanced in a contingent fee case.

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So they take more from the trust than they have a right to take at that point in time. An attorney "borrowing" these funds might have every intention of putting it back, but this kind of situation usually snowballs and ends very badly for the lawyer — as well as the client.

Sometimes either the attorney or someone with access to the trust account has reached a point of greed or desperation. Attorneys with substance abuse problems or gambling addictions can be particularly vulnerable to this type of mistake, but sometimes it happens for reasons that don't appear clear.

This trust account mistake is the one most likely to end a legal career when it's committed by a lawyer, but the lawyer is still the one on the hook for repaying the funds even if it's committed by a paralegal or a bookkeeper.

Commingling Attorney Funds With Client Money

A second major mistake often arises out of a lack of understanding about how a trust account is supposed to work.

Laura A. Calloway, a law practice management consultant at the Alabama State Bar, says:

"Many attorneys don't understand what does and does not go in the trust account. Some run everything, including earned fees, through the trust account, using it as a single general journal for their firms. Others take 'retainers' without understanding that, at least in some jurisdictions, there is no such thing as a non-refundable retainer. So they don't put a deposit against future work into trust as they should, particularly if they need it now to keep the lights on."

A lawyer might tell their client that the legal fees will be $1,000, and the court filing fee will be $200. The client writes the attorney a check for $1,200. Some attorneys will put the entire check into their business accounts because most of the money is going to the lawyer anyway.

But bar association rules require that the check must go into the trust account even if the attorney is entitled to the full attorney's fee immediately. The filing fee portion of that check has to be held in trust.

Some state bar associations prohibit attorneys from having any personal funds in a trust account while others allow attorneys to keep a small amount in the account to cover expenses related to operating the account. The recommended practice is to have all trust account fees deducted from the business account, but this doesn't always happen.

In no case is an attorney allowed to use a trust account as an operating account, a savings account, or a place to hide assets.

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Sometimes lawyers fail to understand that they can't pay bills such as their office overhead expenses directly out of the trust account even when the checks are being written out of funds that have already been earned. Other times attorneys intentionally misuse the trust account as a way to hide assets.

Some attorneys use their trust accounts as rainy day funds. Rather than remove all the fees after they're earned, the attorney delays moving the money from the trust to reduce the risk of spending it. It is both a bad business practice as well as an ethics violation even though the state IOLTA fund might benefit from the extra interest earnings.

Failing to Properly Track Client Funds

The third major way that attorneys screw up their trust accounts is by failing to keep detailed records of each client's trust account transactions.

While most attorneys are good about keeping copies of their trust account checks, not all remember that they should note the client's name or file number on each check when it's issued. And while it might be easy to remember why a check was written a month ago, it might be difficult to remember a year from now.

And although it doesn't happen often, sometimes law offices and all their records get destroyed. A fire can incinerate those paper files pretty quickly as well as destroy the computer hard drive.

If a lawyer finds themselves in a position where they must reconstruct a firm's trust account records using bank statements and copies of old checks ordered from the bank, the task will be virtually impossible unless those checks indicate whose money was being used in each transaction.

Attorneys are required by their bar associations to keep records showing how much money each client has in trust at any given time. Deposits and disbursements must be clearly tracked in some way that makes it easy to determine each client's trust account balance. Otherwise, it would be quite easy to spend one client's money on another client's case.

Attorneys should make sure that their overall trust account is balanced at the end of the month, and they should also make sure that each client's account is balanced. Comparing the balances can reveal accounting errors. This simple step will sometimes catch errors that could have resulted in a bounced trust account check.

Getting Help

Some attorneys realize that their trust accounts are screwed up, but they don't know how to fix the problem. One solution is to contact a law practice management advisor. Many state bar associations now offer free law practice management advice to their members, and a number of private management advisors also offer their services for a fee.

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Some lawyers might be afraid of discussing their trust account situation with a lawyer working for the state bar because of mandatory reporting requirements for ethics violations. But the rules of professional conduct in many states now specifically exclude law practice management consultants from reporting such problems to their ethics board.

Properly managing a trust account can be a hassle, but losing your license to practice over sloppy recordkeeping would be far worse. Lawyers who are having trouble managing their trust accounts should promptly address the problem by getting help from a qualified professional.

FAQs

What is a journal used for in regards to trust account? ›

You must keep a trust account cash receipts journal, recording all money received daily. This must include the: number of the receipt. date the receipt was made out and, if different, the date on which the trust money was received.

How does an Iolta account work? ›

An IOLTA account is a type of trust account that can collect the interest, then transfers the interest collected to the state bar, usually for charitable purposes, primarily the provision of civil legal services for poor people (such as landlord/tenant issues, custody disputes, and advocacy for people with disabilities ...

Does QuickBooks trust accounting? ›

So, that's the starting point: two bank accounts.To prepare QuickBooks Online for trust accounting, you need to create the liability account. That's a detailed trust account liabilities that we'll call “Funds held in trust.” This liability account balances out the bank account — they always need to be in balance.

What are some common sources of inaccuracies in trust account transactions? ›

All in all…
  • Not reconciling daily.
  • Misallocating trust funds.
  • Not establishing trust-specific rules.
  • Not knowing the position of your trust accounts.
  • Hiring the wrong person for the job.
  • Lack of adequate backups.
  • Disbursing funds before a transaction closes.
  • Manually entering in data.
19 Feb 2018

What are 2 reasons that could cause a trust account to become overdrawn or compromised? ›

There are many ways that a trust account can become overdrawn.
...
Some real life examples:
  • Not banking initial sale deposits then finding out that settlement cheques have bounced due to the initial deposit not clearing the account prior.
  • Accidentally uploading EFT payment files twice.
8 Jul 2019

Do lawyers get interest on trust accounts? ›

Sometimes the amount of money that an attorney handles for a single client is quite large. In such cases, lawyers deposit the funds into trust accounts, where the funds can earn interest for the client.

What happens to interest from lawyers trust account? ›

All interest earned from monies on interest bearing deposit will be subject to withholding tax. Monies invested on behalf of a non resident will be subject to Non Resident Withholding Tax. The current rate of non resident withholding tax is 15 per cent in most cases.

Why do attorneys keep two separate types of bank accounts? ›

Separate Client Funds Account

The attorney trust account ensures the separation and security of client funds and helps law firms avoid accidently comingling client funds with law firm funds.

How do I manage trust accounts in QuickBooks? ›

How do i set this Trust account
  1. Click the Gear icon at the top and select Chart of Accounts.
  2. Select the New tab at the upper right corner.
  3. For Account type. Select Other Current Liabilities.
  4. Select Trust Accounts under Detail Type.
  5. Type in your desired name under Name.
  6. Click Save.
30 Jan 2019

Do accountants have trust accounts? ›

Why does a professional accountant in public practice need to open a Trust Account? of the professional accountant. Client monies must be held in a separate bank account that is clearly designated as a Trust Account, which may be used for one or multiple clients' monies.

What is trust bookkeeping? ›

Trust Accounting: This is the process involved in bookkeeping, auditing and reporting so that your trust account remains compliant with the laws and regulations. Trust Accountant: This is an accountant that specialises in overseeing trust accounts.

What happens if there is a discrepancy in the trust accounts? ›

If there are discrepancies found, those are recorded and reported to NSW Fair Trading to action, as required. Internal measures include that the Licensee-In-Charge is the ONLY person to authorise trust account withdrawals.

How do you fix a deficiency in a trust account? ›

Corrective action: Restore any trust account deficiency immediately upon discovery. Provide notification to the Society in writing pursuant to section 260 of the LPA of an irregularity in relation to the trust account records of the law practice.

What are the 2 methods of withdrawing disbursing money from a trust account? ›

Trust money can only be dispersed in accordance with a direction given by the person on whose behalf the money is been held. Further, trust money can only be withdrawn by cheque or electronic funds transfer.

Who can audit a trust account? ›

Who can conduct the audit? Auditors must be qualified under section 115 of the Property and Stock Agents Act 2002. Registered audit companies, authorised company auditors and members of a Professional Accounting Body holding a Public Practising Certificate or Certificate of Public Practice can conduct the audit.

What actions the licensee must take if the trust account become overdrawn? ›

(3A) A licensee must, within 14 days after closing a trust account, notify the Director-General in writing of the closure. (c) the reason for the account becoming overdrawn. (4) Any licensee who neglects or fails to comply with any of the provisions of this section shall be guilty of an offence against this Act.

Why would a lawyer hold money in trust? ›

Because of the nature of certain legal work carried out for their clients, lawyers often hold money belonging to those clients on trust - for example, a lawyer may hold the purchase price of a home a client is buying or a client may leave trust account funds with a lawyer to pay all the disbursements within the case ( ...

Why must an attorney have a trust bank account? ›

Why do lawyers use trust accounts? Trust accounts are used by legal practitioners for holding money on behalf of a client, in connection with the provision of the type of legal service the client needs. For example, where funds are received towards the deposit on the purchase of a property.

How often should a trust account report be given to a client? ›

This report is the foundation of any good accounting process. When maintaining your trust ledger, you need to periodically (usually monthly) compare your internal accounting records, or trust ledger, to your bank statement. This gives you the confidence that your internal accounting records are complete and accurate.

Do trust accounts make interest? ›

Contrary to a common misconception, Solicitors do not earn any interest on clients funds held in their Trust account. In this state, all interest earned on funds in Solicitors Trust accounts is paid directly to the Law Society of New South Wales.

Does money held in trust earn interest? ›

If you are wondering do trust funds gain interest, the answer is “yes, it is possible.” However, they must hold assets that produce income. A trust fund is a type of account that holds a variety of assets for your beneficiaries. Some assets, like a savings account, produce interest, while others do not.

Who gets the interest on an IOLTA account? ›

The interest generated by these accounts fund the Legal Services Trust Fund Program (LSTFP) of the State Bar of California.

What is it called when lawyers take clients money just to keep it? ›

If there is a large sum of money involved or held for a long time, an attorney can hold the client's funds in an individual account, known as a Client Trust Account, and the interest earned will go to the client.

How do you manage a trust account? ›

The Do's and Don'ts of Legal Trust Account Management
  1. DO understand which funds go where. ...
  2. DO have a separation between trust and operating accounts. ...
  3. DO track individual ledgers. ...
  4. DON'T commingle funds. ...
  5. DON'T overdraft ledgers. ...
  6. DO maintain evergreen retainers.

Can a trust have a balance sheet? ›

Unlike a typical business accounting, Trusts and estates don't have a profit and loss statement or a balance sheet. Instead, they use “Credits” and “Charges.” In the simplest of terms, they keep track of what goes in and what comes out.

How do you do a trust in accounting? ›

Trust accounting rules: Know what they are?
  1. No comingling or mixing funds. ...
  2. Maintain a separate ledger. ...
  3. Verify trust accounts regularly. ...
  4. If you haven't earned it, don't touch it. ...
  5. Don't rob Peter to pay Paul. ...
  6. Create checks and balances. ...
  7. Follow state bar and government regulations. ...
  8. No collecting interest.
5 Jul 2018

What is trust liability account? ›

Trust Liabilities means any and all costs, expenses or liabilities of the Trust including, without limitation, Trust Expenses and Extraordinary Expenses.

What does an accounting of a trust look like? ›

Trust accounting is a detailed record that includes information about all income and expenses of a trust. Information that should be included in a trust accounting includes details regarding: Taxes paid, disbursements made to trust beneficiaries, and gains and losses on trust assets.

Why must an attorney have a trust bank account? ›

Why do lawyers use trust accounts? Trust accounts are used by legal practitioners for holding money on behalf of a client, in connection with the provision of the type of legal service the client needs. For example, where funds are received towards the deposit on the purchase of a property.

Who has more right a trustee or the beneficiary? ›

And although a beneficiary generally has very little control over the trust's management, they are entitled to receive what the trust allocates to them. In general, a trustee has extensive powers when it comes to overseeing the trust.

What are the 2 methods of withdrawing disbursing money from a trust account? ›

Trust money can only be dispersed in accordance with a direction given by the person on whose behalf the money is been held. Further, trust money can only be withdrawn by cheque or electronic funds transfer.

What are the 3 types of trust? ›

With that said, revocable trusts, irrevocable trusts, and asset protection trusts are among some of the most common types to consider. Not only that, but these trusts offer long-term benefits that can strengthen your estate plan and successfully protect your assets.

What are the disadvantages of a trust? ›

Drawbacks of a living trust
  • The most significant disadvantages of trusts include costs of set and administration.
  • Trusts have a complex structure and intricate formation and termination procedures.
  • The trustor hands over control of their assets to trustees.

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