Updated: Oct 17
Lawyers have always been one of the most demanding and stressful professions. Despite the fact that a good lawyer requires many years of study and practical experience, managing a successful law firm is a different story. It is hard to find practical guidance at law schools, especially when referring to Lawyer Trust Accounts (IOLTAs) because schools do not always focus on how to deal with them. Most lawyers have little or no knowledge of how to manage a client trust account California before they need to open one. Poor management of lawyer trust account may lead to terrible consequences no one expects. The worst-case scenario could be disbarment in some circumstances. Our law firm bookkeeping services will give you some most common mistakes and how to avoid them.
What is IOLTA and how it works?
You may be required to open an IOLTA bank account if you are an attorney and receive an advanced fee from your client. Lawyers are required to keep the client’s fund in a separate trust account known as an IOLTA. IOLTA is the acronym for Interest on Client Trust Account California. It is a type of Client Trust Account – CTA.
Attorneys often receive retainer fees from clients when they sign a retainer agreement outlining the terms of the attorney's representation. Funds that are kept in an attorney-client trust account include all fee advances and retainers received from clients until they are actually earned when the lawyer performs their work.”
Lawyers are not allowed to earn interest on their clients’ funds by law so the interest generated on these accounts is automatically channeled to the respective state IOLTA board which will deliver those funds to support a charity or educational programs, provide legal civil help to the poor as well as improve the administration of justice.
Attorneys can only earn for what they have worked. For example, a lawyer receives a retainer fee of $12,000 which is then deposited into an IOLTA account. His hourly rate is $100 and he spends two hours working on the client’s case. He is required to move $200 of his billable hours from the trust account into a business account. So, the remaining $11,800 in the IOLTA account is earning interest. That interest will go to the IOLTA program to mainly support different legal services for the poor.
Three common mistakes in Lawyer Trust Account
As a lawyer, you should avoid making these three mistakes related to the IOLTA, or Client Trust Account California. Otherwise, it can lead to serious repercussions that you wouldn’t expect in your career.
1. Borrow money from the account
There is no legal basis for a law firm or attorney to borrow money from any trust account whatsoever. The common reason this borrowing situation happens is that a firm is suffering from financial distress. Your firm might have a cash flow problem due to some unexpected expenses and you can have every intention to pay back the fund as soon as possible. However, the reason is unacceptable when you get into trouble with the authority. This is one of the mistakes that could terminate your legal career. Even if it's committed by a paralegal or a bookkeeper, the lawyer is still the one on the hook for repaying the funds.
This common misuse of attorney-client trust accounts can snowball quickly and become worse and worse. No matter what the reason is, borrowing from a client trust account always results in severe penalties and is one of the most common ways to be disbarred. Therefore, under any circumstances, you should only earn the money after you perform the services.
How to avoid a situation where someone (not the attorney) with access to the trust account has become greedy or desperation? The only way is to strictly monitor your trust account as well as adopt good practices for your trust accounting. It is important that the attorney invests in a good accountant with experience in attorney's trust accounts. It could be an external company that performs this service or an employee of the firm, it doesn’t matter. What matters is their experience and expertise to help organize everything in order and provide advice to improve your accounting process.
2. Failure to separate your client funds and business accounts
A critical and fundamental principle of client trust accounting is keeping a lawyer’s funds separate from client funds, but if a lawyer does not have a solid perception of how a trust account is supposed to work, this rule can be breached accidentally.
Attorneys are allowed to earn from the lawyer trust account, but they are absolutely prohibited from using funds in a CTA or IOLTA to directly pay for a firm’s operating expenses, payroll or taxes included. Instead, the money earned needs to be moved into the firm’s business account first. For example, a lawyer can tell his client the total fee for their case is $1,000 including the legal fees of $800 and the court filing fee of $200. The client writes a check for $1,000. You might think that the firm is allowed to deposit the entire check into their business account because the legal fee part is their income, but actually, that is not legitimately correct. The state bar rules specify that the check must be deposited to the lawyer's trust account even if the lawyer is entitled to the full attorney’s fee. The court filing fee must be kept in trust as it does not belong to the lawyer. This rule is upheld for each IOLTA board for every state.
Besides, an attorney is not allowed to deposit any of their money into a CTA or IOLTA. Some law firms intentionally leave their funds in the lawyer’s trust account after the money has been earned, using it as a “savings” account. These types of actions can be suspected as hiding assets intentionally. Even though the IOLTA program may benefit from extra interest earned, it is a strong violation of ethics and not good practice for business.
3. Failure to Monitor Client Funds accordingly
In order to monitor client funds, it is a good practice for law firms or attorneys to keep detailed records of all transactions in the trust account maintained for each client. Failure to do so may harm their client’s funds.
Most attorneys are excellent in recording legal documents, but not all remember that they should note the client's name or file number on each check when it’s issued. And while it would be easy to remember why a check was written a month ago, it might be difficult to recall after a year or more. This bad habit might lead to misery if unexpected incidents happen, such as a fire destroying all paper files or the state bar surprisingly request up to date records for all of your trust accounts, not just IOLTA.
Attorneys must keep law firm bookkeeping and records that show how much money each client holds in trust at any moment, as mandated by the bar association. Suggestions from the ABA states that IOLTA records should allow tracing “all deposits and disbursements through the account, and each such transaction should be associated with a particular client.”
The mistakes made related to trust accounting usually have more to do with honest mistakes and bad systems than malice. When some attorneys realize they’ve made a mistake, instead of seeking help, they try fixing it themselves which can be devastating if numbers and accounting are not their strengths. Fish cannot climb trees, nobody would judge you if you couldn’t do bookkeeping properly. Be smart, and get help immediately.
You always have the option to hire professionals from outsourced law firm bookkeeping services who have experience in the lawyer trust account.
Irvine Bookkeeping offers a full range of law firm bookkeeping services and promises that in 2-3 weeks, we clean up a whole book for you to prepare for tax seasons. We believe knowing your company's financial health is the key to maintaining control of your business.
As a business owner, if you see that you cannot handle accounting on your own, consider hiring an accountancy service for contractors to help you with it.
Call Irvine Bookkeeping now for a Free Quote!
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