Nearly every lawyer will be responsible for holding onto client funds at some point in their careers, so it’s important to stay current on how to do it right.  

The No. 1 thing to remember? When an attorney is holding the money in a trust account, that money doesn’t belong to the attorney (or their law firm). Instead, the attorney is simply holding the money “in trust” on the client’s behalf until it is ready to be distributed.  

Whenever an attorney or law firm holds funds in a trust account, they’re in charge of client property, and that money must be accounted for to maintain trust account compliance.  

Let’s review the basics of how to do this.  

What is trust accounting? 

In its most essential form, trust accounting is defined as bookkeeping for trust accounts in accordance with legal and ethical requirements.  

Although these requirements vary by state, they do have a couple of key rules in common: 

• 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 

When might an attorney be responsible for a trust account? 

Here are the most common scenarios in which an attorney is responsible for a trust account: 

• For funds received at the start of representation 
• In connection with a payment from a settlement 
• When the attorney is acting as a fiduciary agent on behalf of a client or their estate 

Record-keeping requirements for trust accounting 

To maintain an accurate history of trust accounts for both attorneys and their clients, trust accounting has highly specific record-keeping requirements, which include:  

• Tracking all deposits and disbursements made through the account 
• Keeping a detailed ledger of every monetary transaction for each particular client 
• An account journal for each account that tracks each transaction through the account 
• Regular reconciliation, comparing your internal trust accounting records to the activity in the trust bank account to make sure 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: 

• Settlement funds, such as those obtained through a personal injury case 
• Unearned income paid to the lawyer or their firm before services have been rendered (e.g., fees, cost advances, and retainers) 
• Advances for costs that a law firm expects to incur associated with managing the case  
• 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, there are categories of funds that should never make their way in. Make sure that you never place these types of funds into a client trust account: 

Personal funds 

Placing personal funds into a client’s trust account violates the most important principle of trust accounting: no commingling of funds.  

Note that the category of “personal funds” includes funds that are used by the law firm itself. Only money that is provided by the client or that is to be paid to the client should go into a trust account. 

Earned income 

You should never place wages or other earned income into a client trust account. Once again, the trust account should only contain money that the client provided specifically 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.  

There is never a good reason for a law firm’s payroll function to access a client trust account because payroll expenses should come out of the firm’s operating account.

Rely on the right trust accounting tools 

Especially if you’re keeping track of multiple client trusts, managing all of them can be fraught with potential 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. 

It’s absolutely crucial to get all these aspects of trust accounting right because the risks associated with improper management of trust funds are extremely high. In addition to being fined, lawyers have even lost their 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 CosmoLex to manage their fiduciary duties with regard to trusts, automating their trust management practices to minimize the likelihood of potentially costly human error. 

To learn more about how CosmoLex’s legal trust accounting software can simplify your firm’s processes for trust accounting and management, schedule a one-on-one software demo or sign up for a free trial today. 

Frequently asked questions about trust accounting 

What are the primary responsibilities of lawyers when managing client trust funds, and 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 (here’s some more detailed advice about how lawyers can explain trust accounting to their clients). 

How can lawyers handle trust accounting errors effectively, and what steps should be taken to rectify mistakes in trust fund management? 

Lawyers should address any trust accounting errors promptly, immediately conducting a thorough audit.  

Once they have identified the discrepancies, they should reconcile the accounts, document the corrections they make, and notify any parties that have been affected by the mistake.  

To prevent future trust accounting errors, lawyers can implement stringent accounting procedures, including regular (i.e., at least monthly) reconciliations, in addition to utilizing specialized legal trust accounting software like CosmoLex to minimize the chance of human error going forward. 

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. What’s more, trust accounting is an ongoing activity; law firms must regularly maintain trust accounting records to ensure accuracy.  

Because trust accounting is such an involved activity, law firms should look for software that helps them simplify work and reduce errors. Law firms get the biggest advantage when they leverage comprehensive legal practice management software with built-in trust accounting. Ensuring accurate matter balances, eliminating information silos, and deploying automatic safeguards, built-in trust accounting minimizes points of error in the trust accounting process.