Beyond The Basics: Advanced Trust Accounting Challenges for Law Firms

Misbah Jalal Siddiqui

Beyond The Basics: Advanced Trust Accounting Challenges for Law Firms

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The majority of lawyers know basic trust accounting principles, but throughout the course of business, instances arise that require more in-depth knowledge. Scenarios such as a lawyer leaving the firm and taking their clients with them or the firm needing to switch banks may not be daily occurrences, but it’s still critical that the proper procedures are followed. Going beyond the basics will make sure you’re prepared to handle complex trust accounting situations.

Webinars, articles, and CLEs all tend to focus on the primary trust accounting tenets, including:

  • Managing client ledgers
  • Avoiding commingling of client and firm funds
  • Avoiding ledger overdrafts
  • Proper and timely reconciliation and reporting

There are many other aspects of trust accounting to take into consideration as well. Whether or not you’ve heard of these issues before, they’re critical to maintaining compliance and accurate bookkeeping. Knowledge of these common trust accounting hurdles and how to overcome them will help keep a law firm in compliance and running smoothly.


Knowing the basics of trust accounting sets a solid foundation for understanding more complex issues. If you need a primer on the above trust accounting principles and the basics before diving into the advanced topics, you can check out these helpful resources:


Lawyers have a fiduciary responsibility to manage their clients’ funds properly. The trust accounting challenges in this article go beyond the typical concerns associated with these types of accounts to highlight key pieces that law firms should be taking into consideration. However, like with every challenge, these issues all have a solution.

Transferring Earned Funds From Trust

When funds in a trust account become earned money, there are many other, related accounting tasks that must take place. Each one of these needs to be handled correctly. Otherwise, the books will be thrown into disarray, leading to reconciliation issues.

Generally, to properly book trust to general fund transfers, the following activities have to take place for each transfer:

  • Funds must be withdrawn either as a check or internal bank transfer from the trust bank account.
  • The matter’s trust ledger balance must be updated.
  • Withdrawn trust funds must be applied to the matter’s invoice, updating the current invoice balance.
  • The funds must be deposited into the firm’s operating account(s) as earned funds, booking against various income accounts or cost reimbursements.

Note: These are just the bookkeeping entries. The funds must still be physically transferred from one bank account to another.

Manually handling these various records accurately is nearly impossible. Each of these pieces requires multiple entries and balance adjustments, leaving plenty of room for human error and miscalculation. Technology can often help firms ensure that no mistakes are made and that the record-keeping is precise and complete.

Given the requirements imposed on lawyers that other industries do not have, particularly in relation to trust accounting, legal-specific software is the optimal choice. Commonly used accounting programs like Quickbooks™ and Xero® help keep proper records. However tools built specifically for the legal industry, such as CosmoLex, will take into consideration the unique requirements of law firms and include mechanisms to address them.

Inadvertent Income Shielding

Without even realizing it, a firm could be illegally shielding income and tax. Let’s take a look at a couple of examples which may cause this scenario:

  • For firms doing cash basis accounting (almost all law firms in the US): When invoices aren’t paid from available trust retainers in a timely manner, it can be seen as delaying income to avoid taxes.
  • For firms doing accrual basis accounting (almost all law firms in Canada): When invoices aren’t generated (except for contingency cases) in a timely manner, it can be seen as delaying income to avoid taxes. Incidentally, the Canada Revenue Agency (CRA) has changed the accounting rules recently and is starting to tax WIPs precisely for these reasons.

This method leaves the firm vulnerable to breaking laws on a federal level and should never be used as part of a tax planning strategy. However, often, the issue is not that firms are deliberately trying to shield income, yet that firms often don’t keep proper billing records — which prevents timely execution and can make it appear like a planned effort. make them easily run into this issue.

Be cautious of these following instances that can cause inadvertent income shielding:

  • A lack of knowledge about your accounts receivable and trust account balances
  • Waiting for trust funds to clear and then losing track of them
  • Not having an efficient method in place to conduct trust to general account transfers
  • Commingled trust balances that make it impossible for a firm to tell what can be used as payment

Holds on Funds

Not all client trust funds have the same purpose. Some client trust funds are for fee retainers, others for cost advances, and others for settlement purposes. This means that not all funds can be used to pay firm invoices or used for billing purposes.

It’s imperative to have a system in place which designates what purposes trust funds can be used for. Otherwise, there is a large risk of using them for unintended reasons. If funds are spent from the wrong type of account, it can be extremely difficult to correct the mistake and can be viewed as a misuse of client funds.

Multiple Trust Bank Accounts

While most small law firms have a single trust account, others have multiple trust accounts. Reasons are varied – bank fees charged on wires from client’s bank, larger settlement funds going into a better interest-bearing account, minimizing risks from bank failures, and even the basic need to maintain relations with various banks.

If a firm with multiple accounts chooses to use different banks, the best practice is to keep all of the funds for a particular matter in a single bank. Scattering matter funds across numerous banks can create a number of issues that law firms should be cautious of:

  • Tracking the total matter balance will require adding amounts from different balances
  • A matter invoice may need to be paid in multiple steps if the funds come from different banks
  • Bookkeeping becomes more open to error, as the correct bank account must be selected when dealing with matter transactions
  • Various trust reports should be able to show balances individually by bank as well as aggregated balances.

If you decide to go forward with using various banks for one matter, make sure your software program supports dealing with multiple trust balances for the same matter first. Programs that support this advanced capability, such as CosmoLex, eliminate the need to create multiple matters for the same case, a major practice management challenge. It’s also necessary to maintain bank records and bookkeeping for each of these accounts in the same way you would for an individual trust account. This means separately tracking checks and deposits, completing entries in bank and client ledgers and performing regular reconciliations for each account.

Uncleared Funds

When performing a reconciliation, the focus is generally on what has cleared, but the uncleared funds are just as important. Uncleared funds are normal at the end of every month, especially if the transaction took place within the last few days. Funds that don’t clear for extended time e.g., months, however, present an issue that law firms have a responsibility to address.

The best way to check for funds that remain uncleared for a significant amount of time is to review your monthly reconciliation reports, as these reports list not only cleared transactions but also a list of uncleared transactions. Sometimes the check was lost, or someone may just be holding it. No matter why the funds haven’t cleared yet, the firm is responsible for them until they clear so any ongoing, uncleared funds should be investigated and resolved.

Unclaimed Funds

There are times when the funds in a client trust account must be returned to their owner, which can be harder than it sounds. You may not be able to locate the client, the client may not respond, etc., these are common situations. However, client funds belong solely to the client, they must be handled accordingly, and you must not close any file which has uncleared client funds or a balance.

Within the United States, each state has a process for how to deal with unclaimed funds. For example, in New York, unclaimed client funds are to be deposited to the Lawyers’ Fund for Client Protection. Canada has a similar policy where funds are generally dispersed to the respective Law Society and then after a period of time paid to a non-profit organization. Follow this process and never-ever simply transfer trust funds to your general account and call it a day. That is theft!

Interest Bearing Trusts

Many states in the US utilize IOLTA or IOLA accounts, which are interest-bearing trust accounts. Canada uses a similar interest-bearing account, known as a mixed or pooled account. Typically the interest that is earned is withdrawn on a regular basis by the bank and paid to an institution for the charitable purpose of increasing access to justice and legal services.

Make sure to work with a bank that deposits and withdraws this interest on the same bank statement. If handled on separate statements, client trust ledger balances will include interest at the end of the month only to be removed in next statement. The result is complicated bookkeeping as that interest doesn’t truly belong to the client.

In some instances, such as with personal injury settlement funds, clients are entitled to the interest. These types of funds should be deposited in properly designated accounts in the client’s name. While the client’s name should be on the account, the lawyer, and not the client, should be the signatory.

Merchant Fees

In today’s world, it’s common practice for law firms to accept credit cards not only for invoice payments but also for trust retainers. When choosing to use credit cards as a method of payment for trust account deposits, there are specific requirements for lawyers as to how the credit card merchant should handle the processing of fees or chargebacks. You should always clarify with your bank how these fees are being paid.

The general question is how to pay for the merchant fees – either out of the client’s deposit or from firm funds. As part of compliance, the amount being credited should be the exact amount that is paid by the client. No fees should be deducted prior, to ensure that the deposit matches the client ledger.

Instead, these fees should be deducted from a linked operating account established with the firm. Pulling the fees from the trust account will result in commingling, ledger overdrafts, and messy reconciliations, all of which are substantial compliance concerns. To avoid any potential complications, utilize a merchant that is known to work with lawyers and their unique needs, such as LawPay.

Migration of Client Files When Changing Firms

It’s common for lawyers to change firms. As part of the transition, lawyers are often entitled to bring their existing cases with them to the new firm. These cases can include trust funds, so from a bookkeeping perspective, it’s essential to be mindful of how these funds are handled. In most firms, one trust account is shared by multiple lawyers which can present an issue when it’s time to separate out what belongs to each lawyer.

The best way to handle this is to first identify which clients are staying with the firm and which ones are leaving. Make sure the ledgers are current and accurate with detailed balances for each client. For each client who is leaving the firm, keep proper records of balance transfers — which should equal the total balance being transferred to the lawyer’s new trust account.

Migration of Trust Funds from One Bank to Another

There are many reasons a firm may decide to move their trust account from one bank to another, such as moving their practice to a new location, receiving poor service from their current institution, or as an effort to maintain a particular bank relationship. Any firm making the decision to switch banks should keep in mind that as easy as the task may seem, it’s much more complicated than simply cutting a check from one bank to another as you can do with general accounts. Handling this incorrectly can wreak havoc on your trust bookkeeping, so it’s important to follow all steps needed to keep accurate records.

For each matter, the trust ledger must show a debit and credit to reflect the move. The balances can then be zeroed out and transferred to the new bank. To make sure this is done correctly, the guidelines related to keeping matter funds in multiple banks outlined earlier in “Multiple Trust Bank Accounts” can be extremely helpful.

To see the actual process and how technology can play a role, review Cosmolex’s full support article on Switching Trust Banks.

For a step-by-step guide on how to properly switch trust accounts to a new firm or bank, take a look at the complete guide ‘Maintaining Trust Accounting Compliance While Switching Banks.’

Third-Party Lien Tracking

Lawyers with certain specialties such as personal injury, workers’ compensation, or other practice areas where settlements take place, likely manage third-party liens. These liens come about during a case when a settlement hasn’t been reached yet, and as a result, third-party bills can’t be paid, turning them into liens on the settlement amount. To properly manage these liens so they can be paid, lawyers should track who is owed what amount and if the amount was paid by someone else such as the insurance company.

Knowing the entire amount owed by a client allows for more strategic negotiations when finalizing the settlement amount, with most courts requesting a matter cost statement detailing all bills. If these liens are not factored in the final settlement amount, the client could wind up with little left after all the bills are paid off. Once the settlement is received these bills must be paid before either the lawyer or client receives any funds.


Knowing the ins and outs of how to properly manage trust accounts can seem nearly impossible, but being aware of potential issues and having the knowledge to address them can go a long way. Dealing with trust accounts goes beyond simple bookkeeping. Lawyers need to make sure every aspect involved is in the client’s best interests and protects their funds.

Even unintentional mishaps like income shielding can have significant repercussions for law firms. The time spent preventing those types of errors and any resulting sanctions is worth the investment. As a part of nearly every law practice, trust accounts are a mainstay whose proper handling is critical to maintaining compliance.

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