Lawyers frequently manage client funds using a specific type of bank account called a trust account. Monitoring and maintaining these accounts is called legal trust accounting.
Most commonly, trust accounts are used to pay for legal services, but they may also temporarily hold settlement money or other client-owned funds. Beyond serving as a method of payment or protection for clients, trust accounts also safeguard client funds from misappropriation (intentional or accidental).
Because funds in trust accounts belong to the client and not to the law firm, there are ethical guidelines law firms must follow. Running afoul of these rules can lead to loss of client trust, financial consequences, and even disbarment.
This guide will provide an overview of these core principles behind trust accounting and how it interacts with general accounting practices. We’ll also point you toward the most effective unified platform for these kinds of streamlined accounting practices.
Why do lawyers need to understand legal trust accounting?
As an attorney, “accountant” may not be a desirable title for you. Nonetheless, attorneys have the fiduciary responsibility to protect and manage their clients’ funds—and what a responsibility it is!
A variety of local and national regulations govern client trust accounts. The purpose of these rules is to protect client confidentiality and personal information. This is, of course, a goal most attorneys are happy to work toward.
Still, many attorneys find that following trust accounting regulations is a daunting process. There are numerous rules for reporting, tracking, and transferring client funds. Even a single lapse in following these rules can result in serious consequences, including ethics violations and even disbarment.
This could hurt your firm’s reputation and make it difficult to secure new clients.
But understanding trust accounting isn’t just about avoiding reputational damage. It also allows you to better explain trust accounting practices to your clients, who usually want to know how their money is being handled. This knowledge builds trust and helps your clients feel more secure in their professional relationships with you.
Core principles of compliant law firm trust accounting
The serious consequences of improper trust accounting make it seem intimidating, but keeping your firm compliant—and client funds organized—is easy when you adhere to these essential principles of trust accounting.
Educate legal staff on trust accounting guidelines
Your firm needs an internal policy for managing client funds. All employees at your firm should be familiar with trust accounting basics—including accountants, bookkeepers, paralegals, attorneys, and managing partners.
As you assemble your firm’s policy, ask yourself which details may be relevant to include. Here are some suggestions to use as a starting point:
- What trust accounting is and why it matters
- The local and national regulations that apply to trust accounting at your firm
- How to explain the process of trust accounting to clients
- How to address common issues, such as if a check doesn’t clear
- How to process online payments, such as credit card payments, compliantly
- How long to wait to move client funds from a trust fund to the firm’s operational account after depositing a client check
Protect clients’ personal financial information like your own
You wouldn’t leave your social security or bank account number lying around, would you?
These days, a lot more goes into keeping clients’ personal and banking information private than locking important documents in a file cabinet.
Legal trust accounting software with built-in privacy features can add a valuable layer of security. For example, some trust accounting software includes user-based permissions, a feature that only allows staff access to sensitive information on a need-to-know basis.
Be forthcoming with your clients
At intake, give your clients a written trust accounting agreement. Explain exactly how their money will be deposited and distributed, as well as who will have access to it.
To ensure that clients understand the function and purpose of their trust accounts, review this document with them before they sign.
Don’t forget to explain how clients can access their client portal to check on their accounts and encourage them to do so. This builds trust and empowers your clients to involve themselves in the task of monitoring their funds. It also ensures that any error or violation is recognized and remedied quickly.
Only spend client trust funds as agreed
Never use client funds for operational funds.
Even if you intend to replace the funds as soon as possible, borrowing money from a client’s trust account is more than a violation of trust—it’s illegal.
The national and local bar association could conduct an audit of your trust account reports at any time. Any discrepancies (or misappropriation of client funds) could have dire consequences for your law firm.
Conduct regular reviews, reconciliations, and replenishments
ABA trust accounting rules prohibit overdrafts on client trust accounts. It is all too easy to make this mistake if a client’s trust fund isn’t replenished in a timely manner. Protect your bottom line and remain compliant by closely monitoring your clients’ trust account balances.
Accounting software designed for law firms can track trust balances 24/7 and send alerts when they drop below a certain threshold, so you can collect low balances and apply them to the client’s account before their balance hits zero.
This approach also circumvents the need to place legal matters on pause until the client can deposit funds.
It’s also vital to conduct regular three-way trust account reconciliations. As a trust administrator, you are typically required to perform this balance every 30-60 days, depending on state regulations. These reconciliations can be difficult to do manually, so many law firms turn to legal trust accounting software like CosmoLex to handle three-way reconciliation reports.
Avoid commingling funds
The central tenet of trust accounting is keeping client and operational funds separate. Even accidental commingling of funds can lead to penalties from the ABA or the Law Societies.
Be wary of other forms of commingling. Client trust funds shouldn’t be used for charges that are your firm’s responsibility, like credit card processing fees. Banks aren’t always aware of this rule, so ensure that every transaction comes from the proper account.
Take advantage of the leading legal accounting technology
It’s possible—but difficult—to conduct all of the reporting and bookkeeping associated with trust accounting on your own. Legal-specific accounting software saves time and reduces the likelihood of math and banking errors.
With CosmoLex, all of your law firm’s business accounting and trust accounting needs are handled automatically and in real-time. Client funds are well protected, tracked, and organized with robust reporting features and built-in safeguards that guarantee compliance.
Integrating trust and general accounting to achieve financial harmony at your law firm
Integrating trust and general accounting makes firms’ financial management systems more streamlined and cohesive, improving financial visibility and simplifying compliance.
With improved financial visibility—that is, a comprehensive view of both trust and general accounts—real-time tracking and reporting become easier. When firms can track client funds easily, errors are less likely, and financial reporting is more accurate.
Integrating trust and general accounting also reduces administrative burdens and costs by simplifying reconciliation processes. With more efficient financial management and greater transparency come fewer financial discrepancies and a lower risk of legal issues. In the long run, this can help your firm earn a reputation for trustworthiness.
Ready to stop stressing about trust accounting for good?
CosmoLex is a fully integrated solution for combined trust and general accounting management.
In addition to effectively streamlining your firm’s financials and simplifying compliance, CosmoLex also offers a wide range of robust legal practice management features via one easy-to-use, web-based platform.
To learn more about how CosmoLex’s trust accounting features can integrate with your firm’s general accounting processes—as well as its legal billing and payment processes—schedule your free one-on-one demo or sign up for a ten-day free trial of CosmoLex today.