Trust accounting is one of the most critical and heavily regulated aspects of law firm financial management. Mishandling client funds is the leading cause of attorney disciplinary action.
What Is Trust Accounting?
When clients pay retainers, settlements, or deposits, those funds belong to the client — not the firm. Trust accounting ensures these funds are:
- Segregated: Kept separate from firm operating funds
- Protected: Safeguarded against firm financial difficulties
- Tracked: Individually accounted for by client and matter
- Disbursed: Released only as earned or authorized
IOLTA Explained
IOLTA (Interest on Lawyer Trust Accounts) is a program where:
- Client funds too small or held too briefly to earn net interest for the client are pooled
- The pooled interest is directed to charitable purposes (usually legal aid)
- Every US state has an IOLTA program
- Participation is mandatory in most jurisdictions
Key Rules
Three-Way Reconciliation
Firms must reconcile three records monthly:
- Bank statement: Actual cash in the trust account
- Trust ledger: Firm's record of the account balance
- Client ledgers: Individual client sub-accounts (must equal total)
Prohibited Actions
- Commingling: Mixing client and firm funds
- Borrowing: Using client funds for firm expenses
- Overdrawing: Disbursing more than a client has on deposit
- Earned fees in trust: Leaving earned fees in the trust account
Common Trust Account Transactions
| Transaction | Action |
|---|---|
| Client retainer received | Deposit to trust |
| Fees earned (approved invoice) | Transfer trust → operating |
| Settlement received | Deposit to trust |
| Court filing fee | Disburse from trust |
| Client refund | Disburse from trust |
Technology Requirements
Trust accounting software must:
- Maintain individual client ledgers
- Prevent negative client balances
- Automate three-way reconciliation
- Generate compliance reports
- Integrate with matter management and billing
Best Practices
- Reconcile monthly: Never skip the three-way reconciliation
- Document everything: Keep records of all transactions and authorizations
- Train staff: Ensure everyone handling funds understands the rules
- Separate accounts: Use distinct accounts for different purposes when appropriate
- Audit regularly: Internal reviews catch errors before regulators do