Trust accounting is crucial for lawyers and their firms because it keeps funds separate. The American Bar Association also has the Model Rules for Lawyers’ Fund for Client Protection, which, while not perfect, attempts to create a higher standard of ethics for lawyers.
We’re going to dive into trust accounting in greater detail and best practices that lawyers can follow to adhere to the highest ethics possible.
What is Trust Accounting for Lawyers?
Trust accounting is a way to track and monitor client funds that are held in trust. Funds cannot be accessed early or for reasons unrelated to the client’s case. Rules can vary, but they generally include:
- Funds not being commingled with the firm’s funds
- Detailed records of all money that comes in and out of the account
- The sole use of the funds for the client’s legal matters
Trust accounts often include separate accounts with large sums or pooled accounts that keep funds for more than a single client. If you don’t use trust accounting, client funds can be accidentally spent.
3 Best Practices for Trust Accounting
1. Be Transparent About Billing Practices
Lawyers must be upfront and transparent about their billing practices. Alert your clients from the initial consultation about:
- Existing billing methods
- How much you’ll charge
- How trust accounts work
It’s best to assure clients that their funds will be secure and only used for the services you render to them.
2. Use Three-Way Reconciliation
Three-way reconciliation is one of the safest ways to ensure that trust accounts are accurate, complete, and compliant.
It ensures that three numbers match:
Client Ledger (Balance by Matter)
A client ledger is a summary of all client transactions grouped by individual clients. The amounts recorded for each client should match the amounts in the trust.
Client ledgers serve another important purpose: to provide clients with a transparent view of their trust account balance.
Trust Ledger
The trust ledger is an internal record of all incoming and outgoing transactions of the client’s trust account.
Checks and deposits may not clear on the same day they’re recorded, so they may not match the account balance statement. Trust ledgers, for this reason, play an invaluable role in ensuring accuracy in reconciliation.
Trust Bank Statement
The trust bank statement will list all deposits, withdrawals and interest payments. Because this statement is provided by a third party – the bank – it serves as an effective way to validate transactions listed on the client and trust ledgers.
Timely reconciliations can help prevent accounting fraud and ensure your firm is compliant, so make sure that you’re reconciling the account at the end of every month.
3. Keep Client and Business Funds Separate
The ABA mandates that lawyers must keep their client trust account funds separate from business funds. If, for example, you’re short on payroll, you can’t take funds from trust accounts and replenish them later.
You may have a single trust account with your bank, but every client should have their own sub-account.
Keeping funds separate can be complicated when banks and credit card processors are involved. However, software can help you keep everything on track, create sub-accounts for clients and avoid mishandling funds.
4 Trust-related Pitfalls to Avoid as a Law Firm
Trust accounting is complex, and mistakes can have serious consequences for law firms. Common pitfalls can include:
1. Not Keeping Accurate Records
Having accurate and detailed records is an important component of trust accounting, and this includes maintaining records of all transactions:
- Withdrawals
- Deposits
- Transfers
Software can help your firm streamline this process and help you avoid this pitfall.
2. Not Keeping Clients in the Loop
Lawyers are also required to keep clients in the loop about the status of their trust account, including the account’s balance and fund transfers.
When client funds are held longer than a year, the duty to account annually can be overlooked. However, annual accountancy is an important part of a lawyer’s duty to keep clients advised of the account.
Lawyers should maintain separate ledgers for each client with money in trust accounts. Clients should be able to see their specific ledger at any time.
At the very least, clients should receive their ledger at least once per year.
3. Commingling Funds
The pitfall with the most serious of consequences is the commingling of funds. Lawyers must keep operating and personal funds separate from client trust accounts.
Failing to comply can lead to license suspension or even disbarment.
4. Billing and Income Reporting Issues
Depending on state laws, you may not be able to charge clients processing fees. If your state does allow it, you will need to get the client’s consent to paying these fees in writing.
Along with billing issues, it’s also important to avoid reporting trust accounts as income. The money paid by clients upfront or for a retainer is pre-paid, so it is considered their money until you secure a settlement or carry out all agreed services.
Conclusion
Trust accounting is complex. It’s crucial to ensure that you’re in compliance and following the best practices because otherwise, the consequences can be severe. Consulting with a CPA and adopting the right technology can help keep your firm in compliance.
To learn more about trust accounting for lawyers or how we can help you with your accounting needs, schedule a consultation now!
