Trust accounting is one of the most onerous law firm tasks. Errors, even unintentional ones, can be damaging to attorneys and firms. 

No one wants that. 

So let’s dive right into the top mistakes lawyers can make with trust accounting, tips for avoiding those mistakes, and best practices to ensure your firm protects its reputation and doesn’t become a cautionary tale.

Trust accounting basics 

Attorneys must maintain Lawyer Trust Accounts (IOLTAs) to hold a client’s funds until disbursement. IOLTAs are used to hold retainer fees for clients until the firm earns those funds or funds received on a client’s behalf, such as settlement funds. 

The accounts must comply with your state’s rules, typically adapted from the ABA Model Rules for Client Trust Accounts. These rules explain a lawyer’s fiduciary duty to safeguard trust accounts, including keeping them separate from a firm’s assets, safeguarding them, and maintaining careful record keeping. 

Errors made in trust accounting can be costly, leading to fines, penalties, and civil judgments. Attorneys could even be disbarred or suspended from practice for mishandling a client’s trust funds. That’s why it’s essential to understand the basics of trust accounting and stay up-to-date on related bar association rules. 

Common trust accounting mistakes 

One way to avoid making trust accounting mistakes is to learn from the errors other attorneys have made with their accounts. Here are eight things to avoid. 

Mistake #1: Commingling funds 

You must keep trust accounts separate from all other funds, including operating accounts at your firm. Lawyers may not deposit their money into a trust account, even temporarily, or use it for any other purpose than compensating the firm for services rendered, with proper record keeping. 

To withdraw funds from trust accounts, attorneys should create an invoice for a client detailing the money earned. Only then can the amount of the invoice be paid to the law firm from the client’s trust funds. 

Mistake #2: Failing to maintain detailed records 

Attorneys have a duty to keep very detailed records of trust account monies. Every deposit should be recorded when it’s made. Likewise, any checks issued should be immediately recorded in the check register. Each transaction should be assigned to a client account.  

Failing to maintain detailed records can result in accounting errors. For example, a deposit could be credited to the wrong account. The funds in trust accounts are the property of the client and hence must be managed with the utmost care. 

Mistake #3: Failing to use three-way reconciliation to verify trust balances 

Even though the process is straightforward, many lawyers fail to verify their trust account balances with three-way reconciliation.  

There are three elements of three-way reconciliation: 

• trust bank account statement 
• trust ledger 
• client ledgers 

First, you reconcile the trust account with the trust ledger, much like you would balance your personal checkbook. The bank statement balance should match the reconciled trust ledger balance. The sum of all client ledgers should equal the reconciled trust ledger balance. If not, you forgot to enter a transaction. 

It’s crucial to reconcile each month immediately upon receiving your bank statement.  

Mistake #4: Borrowing money from the trust account 

There is no legal basis for borrowing money from a client’s trust account. Withdrawing money from a trust account for personal reasons or to help the law firm during a cash flow problem is unethical and can result in disbarment.  

The attorney is responsible even if an office manager, associate, or paralegal removes the money from the account. Your intent to repay the money will not be a factor used to decide the punishment for misuse of client funds. 

Mistake #5: Failing to maintain an audit trail 

Every entry should have data to back it up. For example, a deposit entry should include the client’s name, the date, the amount of the deposit, and the reason for the deposit. There should be documentation to verify that data in case of an audit.  

Every withdrawal should include the same data and be accompanied by documentary evidence. 

Auditors generally ask for several reports to conduct a trust account audit, including, but not limited to: 

• Trust account ledgers 
• Bank statements 
• Client account ledgers 
• Bank reconciliations 
• Trial balance reports 
• Deposit records 
• Law firm invoices 
• Proof of expenses reimbursed to the law firm from a trust account 
• Client disbursement statements 

Legal accounting software can be beneficial during an audit because you can quickly create reports, reconciliations, and other evidence to establish an audit trail. 

Mistake #6: Failing to back up data 

Some sources recommend backing up data monthly. However, losing data for your trust account can create an accounting nightmare.  

Backing up data daily is the best way to ensure you don’t lose any information. A comprehensive legal trust account software can automatically perform data backups each day to avoid this problem. 

Mistake #7: Not segregating duties for trust accounts 

Separating duties for the trust account can reduce the risk of fraud and errors. No one at a law firm should be solely responsible for all tasks related to trust accounting.  

It’s wise to assign different people to: 

• Create trust accounts and deposit funds in the accounts 
• Authorize transfers from trust funds 
• Sign trust account checks 
• Perform record-keeping for trust accounting 
• Reconcile trust accounts 

An attorney should maintain control of authorizing transfers from trust accounts. For greater accountability, it can also be beneficial to require the signature of two attorneys on trust account checks exceeding a certain amount. 

Mistake #8: Using manual record-keeping 

Managing trust accounts manually without the help of legal accounting software and automation is one of the common mistakes law firms make. Human error happens. Automation helps avoid human error, keeps you compliant, and helps you identify issues and correct them before a problem arises. 

Best practices for managing law firm trust accounts 

Safeguarding a client’s trust account funds is a top priority for lawyers. This checklist of trust accounting best practices can help ensure your firm is compliant: 

• Maintain separate ledgers for each client 
• Ensure all employees are trained in compliance issues 
• Periodically review bar association rules for trust accounts 
• Keep copies of all checks and monies deposited in the trust account 
• Place copies of checks written from the trust account with the invoice, statement, or other record authorizing the release of the funds 
• Reconcile the trust account within 24 to 48 hours after receiving a bank statement using three-way reconciliation 
• Back up trust account data daily 
• Delegate trust accounting tasks to different people to prevent fraud and abuse 
• Use transparent billing practices 
• Take advantage of legal trust accounting software to make tracking, reporting, and transferring client trust funds safer and easier 

Mishandling client trust accounts can result in serious financial trouble for law firms and attorneys. Trust accounts require constant supervision to ensure client funds are allocated correctly, and managing trust accounts by hand can be challenging.  

That’s why one of the best practices for trust accounting is to utilize trust accounting software to do some of the work for you. 

Elevate your law firm accounting with CosmoLex 

General accounting software like QuickBooks is insufficient for managing law firm trust accounts. You need legal-specific software to ensure you comply with all rules and regulations. 

CosmoLex gives you complete accounting services plus practice management for your law practice. With CosmoLex, you can elevate your law firm accounting to ensure your trust accounts are always current and compliant. Best of all, the process is automatic, eliminating the errors and oversights that can occur with manual trust accounting practices. 

Schedule a free demo and discover the peace of mind that comes when you automate your law firm’s accounting tasks and use a complete legal practice management solution with integrated legal accounting.