Law Firm Trust Accounting: A Complete Guide for Small Firms

What is law firm trust accounting?

Trust accounting is the bookkeeping that tracks money a firm holds for other people: retainers, advance fees, settlement proceeds, and funds held for a third party such as a medical lienholder.

In short: the money belongs to someone else, so the books must show whose it is, at all times.

The ABA comment to Rule 1.15 says a lawyer holds client property with the care of a professional fiduciary, and that books and records should be current and follow generally accepted accounting practice. It points to the ABA Model Rules for Client Trust Account Records for the detail.

Why does trust accounting matter for a small firm?

Small firms carry the same duty as large ones with fewer people checking the work. The State Bar of Texas says trust account errors frequently bring lawyers into the disciplinary system, and its lead tip is to reconcile monthly.

Its trust account guide adds that supervising lawyers answer for their staff. In short: the lawyer is responsible for the account even when someone else keeps the books.

How does an IOLTA account work?

IOLTA stands for Interest on Lawyers' Trust Accounts. A small amount of client money held for a short time cannot earn net interest for the client. Pooled in 1 account, those balances add up to money for legal aid.

Where a client's money goes depends on whether it can earn net interest for that client, meaning more than the cost of collecting it. The ABA Commission on IOLTA describes the split.

The lawyer may not benefit from client funds. And even in a pooled account, the firm still tracks each client's money on its own ledger, even though the bank sees 1 balance.

IOLTA programs operate in all 50 states, DC, Puerto Rico, and the US Virgin Islands. Details differ. California, for example, puts funds that can earn income for the client in a non IOLTA account under the client's taxpayer ID, per the State Bar of California guidelines.

What do the law firm trust account rules require?

Here is ABA Model Rule 1.15 in plain English.

• (a) Keep it separate. Client and third party property stays apart from the lawyer's own. Funds go in a separate account in the state where the office is, or elsewhere with consent. Records are preserved for 5 years after the representation ends, a bracketed number each state fills in for itself.
• (b) Your own money stays out. The firm's funds go in the trust account only to pay bank service charges on that account, and only the amount needed.
• (c) Advance fees stay in trust until earned. Fees and expenses paid in advance are deposited in trust and withdrawn only as fees are earned or expenses are incurred.
• (d) Notify, deliver, account. When funds arrive that a client or third person has an interest in, the lawyer promptly notifies them, promptly delivers what they are entitled to, and gives a full accounting on request.
• (e) Disputed money stays put. If 2 or more people claim an interest in funds, the disputed amount stays separate until resolved. The undisputed portion is distributed promptly.

The rule itself sets no reconciliation frequency. That comes from the records rules below.

The comment adds that a third party can have a lawful claim on funds, such as a creditor's lien on a personal injury recovery.

What records does a trust account need?

The ABA Model Rules for Client Trust Account Records list what to keep for 5 years after the representation ends. Use this as a checklist:

• Receipts and disbursements journals: date, source, and description of each deposit; date, payee, and purpose of each disbursement.
• A ledger for each trust client: source of funds, who the funds are held for, amounts, withdrawals, and who was paid.
• Retainer and compensation agreements.
• Accountings to clients or third persons, bills for fees and expenses, and records of disbursements made on a client's behalf.
• Checkbook registers, bank statements, deposit records, prenumbered canceled checks, and substitute checks.
• Electronic transfer records, with who authorized it, the date, the recipient, and the bank's confirmation.
• Copies of the monthly trial balances and quarterly reconciliations.
• The parts of client files tied to trust transactions, such as settlement statements issued to the client.

The records rules safeguards also say only a lawyer admitted in the jurisdiction, or someone under that lawyer's direct supervision, may sign on the account or authorize transfers. Withdrawals go to a named payee, never to cash.

How often should a law firm reconcile its trust account?

The ABA comment to the records rules says quarterly is only the minimum, and monthly reconciliation is the preferred practice because finding an error across 3 months of activity is hard. State examples are in How Often Should Trust Accounts Be Reconciled?

The ABA material does not use the phrase "3 way reconciliation." It describes the substance, and what many bars call a 3 way reconciliation works like this:

1. Add up every client ledger balance. That total is the trial balance.
2. Compare it to a control balance: last month's balance, plus the month's receipts, minus the month's disbursements.
3. Reconcile to the bank. Starting from the book balance, add outstanding checks and subtract deposits the bank has not credited yet. The result should agree with the bank statement.

The step by step method has its own guide: 3 way reconciliation for trust accounts.

Example figures, not a real firm. The reconciled bank balance is $48,500.00 and the trust account in the books is also $48,500.00. The client ledgers look like this:

Bank, books, and ledgers all agree on the total, yet Client C's ledger sits below zero. Client C's payments were funded by money held for Client A or Client B. A bank rec alone would never show it. The 3 way check does, and the gap has to be explained and fixed in the same month.

How do trust accounting rules differ by state?

Here is how 4 states compare with the ABA model.

Where a rule states no frequency, the work remains: the State Bar of Texas guide calls monthly reconciliation practical, wise, and necessary. Rules change over time, so check your state bar's current text before you rely on any row above.

What is commingling, and when is it allowed?

Commingling means putting or leaving the firm's own money in the client trust account, mixed with client money. The ABA comment says it is normally not allowed. Rule 1.15(b) makes 1 exception: money needed to pay bank service charges on that account, with accurate records showing which part is the firm's.

States add their own. Florida, for example, allows deposits to replenish a trust shortage, up to the shortage, with immediate notice to the Bar.

Examples and how to avoid them are in Commingling Client Funds.

How do you pay out a settlement from trust?

Money leaves trust only for the person entitled to it. Rule 1.15(d) requires prompt delivery and, on request, a full accounting, and 1.15(e) keeps disputed amounts in trust. For contingent fee matters, ABA Rule 1.5(c) requires a written statement at the end showing the outcome and, if there was a recovery, the amount sent to the client and how it was determined.

In my own disbursement work, each medical provider or lienholder payment comes from a reduction or payoff letter. I read it for who to pay, where to mail it, the approved amount, and the letter's reference number. A human reviews and signs off before any trust check goes out.

The full process is in Settlement Disbursement Statement: How Personal Injury Firms Pay Out a Settlement.

Can you do law firm trust accounting in QuickBooks Online?

Yes, with care. I work in QuickBooks Online, and it can hold trust records. The monthly process around it is what keeps them right.

Intuit's article on recording a retainer or deposit treats client money as a liability, because the business holds it but has not earned it. For a client by client view, Intuit's method is a Balance Sheet drill down on the trust liability account, grouped by customer.

That article does not cover 3 way reconciliation, IOLTA interest, or state rules. You still run those yourself. Setup details are in QuickBooks Online for Law Firms.

What are the most common trust accounting mistakes?

• A negative client ledger. The totals can agree while 1 client ledger is below zero, which means that client's payments were funded by money held for others.
• Paying operating bills from trust. The Texas comment to Rule 1.15 says a lawyer should not pay the firm's general creditors directly from trust, even with money due to the lawyer.
• Withdrawing fees before they are earned. Under Rule 1.15(c), advance fees come out only as they are earned.
• Mixing your own money in beyond bank charges. The ABA exception is for bank service charges and nothing else.
• Leaving earned fees in the account. Leaving the firm's money there is commingling. California, for example, requires the lawyer's share out at the earliest reasonable time once it is fixed.
• Reconciling late. The ABA prefers monthly because an error across 3 months of activity is hard to find.

What does a monthly trust routine look like?

I run the close as a set of 6 proofs, each checked off on its own. Trust sits inside them.

1. Every bank and card account ties to its statement, to the cent.
2. Trust passes the 3 way check: the bank statement, the trust account in the books, and the total of all client ledgers agree.
3. No client ledger sits below zero.
4. Every open item is written down with an owner, not left in someone's head.
5. The period is locked so nobody posts into a closed month by accident.
6. The firm gets a short summary of what changed and what is still open.

Close prep starts 3 days before month end, and the close takes 3 to 5 days. Client questions go out as soon as they come up, not after the bank rec. Every close gets a separate review pass before it reaches the firm. Any gap gets explained and fixed in the same month.

In short: a close is a set of proofs, not a date on the calendar.

When should a firm get outside help with trust accounting?

Consider outside help if any of these sound familiar:

• You are behind on reconciliations, and the gap grows each month.
• The client ledgers do not tie to the bank, and nobody can say why.
• Nobody owns the close, so trust gets done when there is time.

Whoever does the work, the lawyer stays responsible for the account. The 6 proofs above show what a close should prove each month: trust tied, no negative ledgers, and every open item owned.

FAQ

Who gets the interest on an IOLTA account?

The bank sends it to the state IOLTA program, which funds legal services. Neither the client nor the firm receives it. Funds that can earn net interest for the client go in a separate non IOLTA account instead, with the interest earned for that client.

What are the law firm trust account rules?

Under ABA Model Rule 1.15, client funds stay separate from the firm's money, advance fees come out only as earned, clients are notified and paid promptly, and disputed money stays put. Each state has its own version.

Can a law firm pay its own bills from the trust account?

No. Under ABA Rule 1.15(b), firm money goes in trust only to cover bank service charges. Firm expenses are paid from the operating account, and earned fees move from trust to operating.

Can QuickBooks Online handle law firm trust accounting?

QuickBooks Online can track client funds as a liability and show a balance by customer, per Intuit's retainer article. The 3 way reconciliation and your state's rules are still yours to run.