Lawyers go to law school—and graduate to find themselves running businesses. Yet whether you’re starting a solo practice or growing an existing firm, the same accounting rules apply.
Every law firm should have three basic bank accounts: an operating account, a savings account, and a trust or IOLTA account. And despite trust laws varying state-by-state, there are also a few common accounting practices that apply across the board.
An operating account is the law firm’s checking account. It’s where money is deposited when client invoices are paid. It’s also the account that firm expenses are paid from, including salaries, insurance, and utility bills.
Not all law firms use credit cards because having a line of credit or a business loan will provide better loan interest rates. However, for firms that use credit cards to be savvy about covering certain business expenses while still paying the credit bills on time, payments should always come out of the operating account.
Every law firm should also have a savings account. While savings accounts are not known for having great interest rates to keep up with inflation, having extra cash on hand is an important safety net for any business.
These are funds to cover you in case of an emergency, and a savings account will yield better interest rates on money you’re setting aside to pay your taxes than a checking account will.
Moreover, you can shop around for banks or credit unions that offer better interest rates on their savings accounts. In particular, money market accounts may be a preferred option for some law firms because they offer a higher interest rate and federal insurance. However, you must maintain a minimum balance and some banks will charge fees if you go beyond a certain number of transactions each month.
If you ever need a business loan, having money in a savings account will help you qualify for one.
Trust or IOLTA account
The third bank account law firms should have is a trust or IOLTA account. If a client pays an advanced fee or security retainer for services your law firm will perform, that money should be deposited in the trust or IOLTA account.
Trust accounts are tricky because they are operated by the law firm but they technically hold clients’ money. In fact, the money in a trust account doesn’t belong to a law firm until they have completed work for the client, billed for that work, and given the client enough time to receive and object to the bill, if they choose. Only then can a law firm transfer money out of the trust account and into their operating account.
Additionally, every state has different regulations around exactly how trust accounts should be handled as well as special record-keeping and reconciliation requirements—more on that below.
When picking a bank or credit union to open a trust account with, take a moment to shop around and make sure they have an understanding of how trust accounts in your jurisdiction must operate. You can always speak with other lawyers or ask at your State Bar for a list of banks that work with law firms.
Accounting dos and don’ts
Most of the accounting trouble law firms run into has to do with their trust or IOLTA accounts. Regulations do vary by state, but keep in mind the following dos and don’ts no matter where you practice.
Do treat the trust account as other people’s money
At the end of the day, the funds in the trust account are still legally your clients’ money, not yours. You can’t access that money early—i.e. before doing the work and billing for it—no matter what.
In fact, it’s because of how unusual the trust account structure is that there are so many regulations in place. Clients place a lot of trust in their lawyers, so the rules are designed to help protect them.
Don’t forget to keep consistent records
No matter where you live, your State Bar will require consistent record-keeping of all client trust accounts. If you’re ever audited, you’ll be asked to produce this information.
There are several different records you need to keep, but it’s especially important to know that you’re responsible for tracking individual client funds, as well as the trust account overall. Every transaction and penny must be accounted for.
Do use a legal-specific credit card merchant
Accepting credit card payments from clients makes sense on a lot of levels. Clients almost always find it more convenient to pay with a credit card—making them more likely to pay promptly—and accepting online payments can streamline the billing process for law firms.
However, the strict regulations around trust accounts mean they’re not set up to handle generic credit card merchants. The credit card service fees can’t come out of the trust account because they’re the law firm’s fees to pay, not the client’s. But the client’s payment can’t initially be deposited in the law firm’s operating account. It must go directly into the client trust account instead.
Legal-specific credit card merchants are prepared to deposit fees into one account (the trust account) and withdraw them from another (the operating account). We always recommend working with a legal-specific merchant to avoid unintended trust accounting violations.
Don’t commingle funds
The law firm’s money and the client’s money must be kept separately. The law firm can’t pay bills directly out of the client trust account. Instead, funds in a client trust account must be deposited into the firm’s operating account as payment for an invoice that the client has already received and all appropriate records must be made. Only then can the funds be used to pay a bill.
Similarly, funds that have been earned by the law firm can’t be left in the trust account as a substitute for a savings account. Instead, they must be moved into the firm’s operating account and then into the firm’s savings account.
Do run regular reconciliation
In addition to keeping clear records, your State Bar will also ask you to run regular reconciliation, and in particular, regular three-way reconciliation.
Three-way reconciliation involves cross checking all the transactions of individual client ledgers, the trust account ledger, and the trust bank statement. Depending on where you practice, this process needs to be completed every thirty to ninety days.
Running reconciliation can be time-consuming and exhausting, so this can be a good time to leverage your practice management system’s accounting platform. A good legal-specific practice management system can quickly and accurately run three-way reconciliation for you, saving you time and ensuring you have all the required paperwork up to date in the event of an audit.
Keeping your finances organized
Keeping appropriate records, following trust regulations, and running regular reconciliation and three-way reconciliation can be a lot of legwork for any law firm.
But a good practice management system can significantly decrease your accounting workload and help you stay compliant through trust accounting safeguards.
Keep abreast of the specific rules of your local jurisdiction and leverage your tech options, and you’ll be well on your way to a more streamlined accounting process for your law firm.