Trust Accounting for Lawyers:
Strengthening Client Relationships
Nearly every lawyer will be responsible for managing client funds at some point, and knowing how correctly protects client relationships and helps avoid legal issues.
When holding money in a trust account, the number one thing to remember is that it doesn’t belong to the attorney or the firm. Instead, the attorney holds the money “in trust” on the client’s behalf until it’s ready to be distributed.
When attorneys hold funds in a trust account, they’re in charge of client property, and that money must be accounted for to maintain trust account compliance.
Mastering the basics of trust account management helps law firms expertly handle client funds and ensure the integrity of accounting operations.
What is trust accounting?
Trust accounting is bookkeeping for trust accounts in accordance with legal and ethical requirements. Proper trust accounting practices prevent the misuse of client funds and instill and uphold trust between your firm and clients.
Although the requirements vary by state, two rules apply to all trust accounting practices:
- There is to be no commingling of client funds with those of the lawyer/law firm
- The firm must maintain accurate records of the trust account
Clients expect that law firms know how to manage finances responsibly. Lawyers are legally and ethically obligated to handle client funds with as much care as possible. This means keeping client money separate from the firm’s. Law firms show transparency and accountability by keeping records of all fund transactions on behalf of clients.
Trust account management directly reflects a law firm’s professionalism. Failing to handle client funds correctly can risk your firm’s reputation and credibility and cause you to lose clients and future business.
When might an attorney be responsible for a trust account?
An attorney may be faced with trust accounting at several stages when working with clients. When a firm first represents a client, it may receive retainer fees or other deposits to put into a trust account. Settlement payments are another example; this is when the attorney manages and distributes funds on behalf of the client.
When an attorney serves as a fiduciary agent on behalf of an estate, they’re also required to funnel the funds through a trust account. Ultimately, trust accounting exists to protect clients and help firms comply with industry regulations.
Record-keeping requirements for trust accounting
To maintain an accurate history of trust accounts for attorneys and their clients, trust accounting has specific record-keeping requirements, including:
- Tracking all deposits and disbursements made through the account
- Keeping a detailed ledger of every monetary transaction for each client
- An account journal for each account that tracks every transaction
- Regular reconciliation, comparing internal trust accounting records to the activity in the trust bank account to ensure they’re consistent
Which kinds of funds can be placed in a trust account?
Only certain types of funds can be placed into a trust account:
- Unearned income paid to the lawyer or their firm before services have been rendered (e.g., fees, cost advances, and retainers)
- Judgment funds awarded by the court (like some settlement funds)
- Third-party funds, including those obtained from the sale of client property or designated for payment to a third party for their services
Funds that should never be placed in a client trust account
Just as only some funds may go into a trust account, specific funds should not be included. Your law firm should never place these funds into a client trust account:
Personal funds
Placing personal funds into a client’s trust account violates the core principle of trust accounting: no commingling of funds.
Personal funds refers to funds used by the law firm itself. Only money provided by the client or which is to be paid to the client should go into a trust account.
Earned income
Never place wages or other earned income into a client trust account. Once again, the trust account should only contain money the client provided expressly for designated purposes.
Payroll
Attorneys must never use a client trust account to manage payroll. This is another violation of the rule against commingling of funds.
In fact, no case exists where a law firm’s payroll function would access a client trust account because payroll expenses should come from the firm’s operating account.
Rely on the right trust accounting tools
Managing multiple client trusts can be fraught with challenges. You must track each trust independently, maintaining a thorough paper trail to ensure there’s never a question that the funds were used improperly.
Getting all these aspects of trust accounting right is crucial since the risks associated with improper management of trust funds are high. In addition to being fined, lawyers can even lose licenses over what amounts to bad record-keeping.
How can law firms avoid the problem in the first place? Rather than relying on manual tracking or generic accounting software that isn’t designed to meet the needs of the legal industry, use specialized legal trust accounting software.
CosmoLex takes the stress out of trust accounting
More and more lawyers and firms are turning to legal software solutions like CosmoLex to manage their fiduciary duties concerning trusts. By automating your accounting practices, your firm will minimize potentially costly human errors, safeguard your business, and keep you compliant with trust reporting requirements.
CosmoLex’s legal trust accounting software can simplify your firm’s trust accounting and management processes. We take the guesswork out of navigating these complex accounts and give you peace of mind and confidence in handling trusted financial data.
Protect and strengthen your most crucial business asset: your client relationships. Schedule a one-on-one demo or sign up for a free trial today.
Frequently asked questions about trust accounting for lawyers
1. What are lawyers’ primary responsibilities when managing client trust funds? How can they ensure compliance with legal and ethical standards?
Lawyers managing client trust funds have the following key responsibilities:
- Safeguarding the funds in the trust accounts
- Keeping the trust funds separate from those of the firm
- Maintaining accurate records of the account (trust accounting)
To ensure compliance with legal and ethical standards, lawyers should adhere to their state’s rules regarding trust accounting, reconcile the account on a monthly basis, keep diligent records of the account, and communicate clearly and transparently with their clients about their trust accounts.
2. How can lawyers handle trust accounting errors effectively? What steps should be taken to rectify mistakes in trust fund management?
Lawyers should promptly address trust accounting errors by conducting a thorough audit.
Once you’ve identified the discrepancies, reconcile the accounts, document corrections, and notify any parties affected.
To prevent future trust accounting errors, lawyers can implement stringent accounting procedures, including regular (at least monthly) reconciliations, and utilize specialized legal software tools like CosmoLex to minimize the chance of human error going forward.
3. What technology or tools can lawyers use to simplify the trust accounting process while maintaining accuracy and compliance?
Trust accounting is a multi-step process involving numerous points of data. It’s also an ongoing activity in which law firms must regularly maintain records to ensure accuracy.
Because trust accounting is so involved, law firms should utilitze software that helps them simplify work and reduce errors. Leveraging comprehensive legal practice management software with built-in trust accounting gives law firms an advantage by improving efficiency and accuracy. Built-in trust accounting minimizes missteps by ensuring accurate matter balances, eliminating information silos, and deploying automatic safeguards.
