All Law offices, including solo practices, are required to have two bank accounts: an operating account and a trust account (IOLTA). Operating funds belong to the firm, while trust funds are held for others. Proper management of both accounts is complex and often necessitates a billing package to streamline the process.
Below we will look at the key differences between the 2 accounts to help you get a better understanding of the requirements.
What are the key differences between Client Trust / IOLTA Accounts?
Trust and IOLTA accounting requirements for law firms in the US vary by jurisdiction. However, there are a set of guidelines that are common across all jurisdictions. If you are unsure, it will be best to seek the advice of a professional accounting firm. Lescault and Walderman offer a free first consultation for law firms.
|Separation of Funds: Trust accounts must be separate from the law firm’s operating accounts to ensure that client funds are not mixed in with the firm’s funds.
||Eligibility: Law firms must meet certain eligibility criteria to open an IOLTA account, which may include being in good standing with the state bar association or being authorized to practice law in the prescribed jurisdiction.
|Designated Account: The trust account should be designated as a trust or escrow account and clearly identified as such.
||Participation: IOLTA participation may be mandatory or voluntary, depending on the state. Some states require all lawyers and law firms to participate in an IOLTA program, while others allow voluntary participation.
|Trust Account Registration: The law firm must register the trust account with the appropriate regulatory authority, such as the state bar association or the state’s attorney regulatory body.
||Approved Financial Institutions: IOLTA accounts must be held in financial institutions that are approved or designated by the state’s IOLTA program. These institutions are typically FDIC insured.
|Trust Account Agreement: Some jurisdictions require a written agreement between the law firm and the financial institution holding the trust account. This agreement details the terms and conditions related to the trust account.
||Account Registration: The law firm must register the IOLTA account with the state’s IOLTA program or the appropriate regulatory authority. This process may involve providing specific information about the account like the account holder’s name and address.
|Interest on Trust Accounts: Some states require law firms to set up interest-bearing trust accounts, where any interest earned on the funds is designated for specific purposes, such as legal aid programs.
||Interest Calculation and Distribution: Financial institutions that hold IOLTA accounts calculate and distribute interest earned on these accounts in accordance with state guidelines. The interest is typically remitted to the state’s IOLTA program or a designated charitable organization to support legal aid and access to justice initiatives.
|Record Keeping: Accurate and detailed records must be maintained for all transactions involving the trust account. This includes receipts, disbursement records, bank statements, and other relevant documentation.
||Record Keeping: Accurate and detailed records must be maintained for all transactions involving the IOLTA account. This includes receipts, disbursement records, bank statements, and other relevant documentation.
|Reconciliation: Regular reconciliation of the trust account must be done to ensure that the account balance matches the firm’s records and to identify any discrepancies.
||Reconciliation: Regular reconciliation of the IOLTA account is a must requirement as it ensures that the account balance matches the firm’s records and identifies any discrepancies.
|Trust Account Audits: Law firms may be subject to periodic audits or inspections by the regulatory authority to verify compliance with trust account rules and regulations.
||Reporting Requirements: Law firms may be required to submit regular reports to the state’s IOLTA program or the regulatory authority regarding their IOLTA account activities, including account balances, deposits, and withdrawals.
|Reporting Requirements: Law firms may be required to submit regular reports to the regulatory authority regarding their trust account activities, including account balances, deposits, and withdrawals.
||Compliance Audits: Law firms may be subject to periodic audits or inspections by the state’s IOLTA program or the regulatory authority to verify compliance with IOLTA rules and regulations.
|Client Notification: Law firms must inform clients in writing about the establishment of the trust account and provide them with relevant details, such as the account number and the financial institution’s name.
||Client Notification: Law firms must inform clients in writing about the use of an IOLTA account, including details about the interest earned and its distribution.
What are some of the challenges with managing them?
Now that we have a ground-level understanding of the two account types it is important to take some time to go through the challenges of managing them and what to check to fix now and what to avoid in the future.
We have created a list of 9 trust accounting mistakes that we have experienced in law practices over the years:
- Recruitment Process: Evaluate a potential employee’s diligence in managing accounts by testing their knowledge with practical examples during the interview. Additionally, it is crucial to thoroughly check the candidate’s previous employer references. Consider employing them on a trial basis before making a final commitment to permanent employment.
- Not establishing trust-specific rules. Ensure you have a documented set of company rules and policies around the management of the accounts that are signed by all relevant parties so they understand their duties. There is nothing worse than something going wrong and the staff member says they didn’t know.
- Manually data entry. Manual accounting entries are prone to human error and trying to backtrack and reconcile accounts manually is time-consuming and labor intensive. Ask yourself what will happen if the person leaves before you pick up the error. This will only make the reconciliation that much more difficult.
- Not reconciling the accounts daily. If you have very active accounts this step will help pick up any errors quickly before they become lost in weeks or months entries. A daily reconciliation keeps errors to a 24-hour period which is quick and easy to fix, in most cases.
- Not knowing where your trust accounts are standing. It is important to have a solid grasp of your law firm’s financials at all times to ensure a smooth operation. You don’t want to be in a position where the business needs money urgently only to find the accounts are a mess and the bank balance is zero.
- Misallocation of trust funds money. This is a big one and requires due diligence at all times from the people in charge of the accounts. If money is spent incorrectly and you are in an audit the work environment can become intense as penalties and fines start to loom over the law firm while you trying to maintain an air of professionalism with your clients.
- Lack of adequate backups. Make sure that all your data is on a daily backup. If you are about to be audited and don’t have access to important data because it was not backed up will lead to issues in the audit.
- Disbursing funds before a transaction closes. This is a very risky practice that happens from time to time due to a lack of oversight. It means that funds were released or transferred to parties involved in a transaction before the completion of all contractual obligations and the official closing of the deal. This can lead to potential legal and financial complications if the transaction does not proceed as planned or if there are unexpected issues that prevent the closure.
Key points on Managing Client Trust / IOLTA Accounts
Before going through the checklist the below are important things to consider when looking at your law firms management of Trust / IOLTA Accounts
- Specialization: Ensure you have the correct staff with the right skill set to manage trust / IOLTA accounts.
- Accountability: Have a set of clearly defined roles and responsibilities for each person involved and have it documented.
- Oversight: Use a framework to have a clear segregation of duties. The most popular frameworks are the “Financial Oversight and Compliance Framework” and “Financial Management and Trust Accounting Framework.”
- Reporting: Generating reconciliation reports on a regular schedule. This should be done monthly to align with your bank accounts.
- Compliance: The best practice in trust account reconciliation calls for performing this process consistently periodically, typically monthly or quarterly as dictated by your state.
Checklist for managing client trust & IOLTA accounts:
- Who has access to each tool and software in the management of my IOLTA/trust accounts?
- Who is responsible for the performance of trust account reconciliation?
- Have I documented the people responsible?
- Have they signed the company operating manual and policies on managing IOLTA and trust accounts?
- Does my banking software and trust accounting software allow for user management with different rights and privileges within the application?
- Have I segregated the system administrator’s duties? These are the staff who can grant/remove access from the individuals performing reconciliation.
- Does my software have an audit trail with an easy-to-read and access log that cannot be manipulated?
- Does it keep records of which user performs each activity and when?
- How long are these records kept and where are they stored?
- Does my internal process support consistent and verifiable 3-way reconciliation of the law firm’s IOLTA account, client ledger, and trust accounting balance?
- Does my banking and trust accounting software offer a simple and easy-to-use interface that supports easy, quick, and accurate integration across the three critical sources of your bank statement, client ledger, and accounting balance?
With all of the above taken into consideration I’m sure we can agree that trust fund management in the legal realm can be a real labyrinth of complexity. Without a reliable law office billing program that can clearly distinguish between trust accounts and operating accounts, it’s like walking on thin ice as you know trouble is just waiting to happen, the question is when and how much will it cost you. In today’s age relying on the old-age accounting system of human memory or hastily scribbled notes to keep tabs on which money is rightfully yours and which belongs to clients is a recipe for disaster.
So always veer on the side of caution and stay on the safe side. Consider an appropriate billing program as it will help your law firm maintain a clear and accurate separation between funds. Having this financial tool at your disposal will keep operations smooth and keep your firm compliant with ethical and legal standards. Don’t let the intricacies of trust accounting catch you off guard; instead, opt for a solution that lightens the load and keeps your firm on solid financial ground.
Trust me, a little technology can save you from a whole lot of headaches!
Does all of the above seem daunting and too much to handle when you have to focus on billable hours for your law firm?
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