Law firms tend to accept and keep money from their clients or third parties. Some of those include settlement payments, advance fees, and court costs which have to be kept separately from the business account of a firm and distributed later on. In this regard, an IOLTA account plays an essential role in the trust accounting for lawyers.
In this blog, we will discuss what an IOLTA account is, how it works, and why law firms choose this option. Furthermore, we will highlight some mistakes that are commonly made by lawyers in their accounting and how to avoid ethical problems. We will provide some practical recommendations regarding client ledgers, trust account reconciliation, supervision of staff, and keeping money safe. Since IOLTA rules differ per jurisdiction, you should consider the rules of your state.
What Is an IOLTA Account and How Does It Work?
IOLTA means Interest on Lawyers' Trust Account. The IOLTA account may typically be utilized to deposit qualifying funds of clients or third parties which are nominal in value or anticipated to be kept for a short duration of time. In place of the interest being retained by the lawyer or individual client, interest earned from the IOLTA program may typically be channeled for the purpose of legal aid.
1. IOLTA Keeps Client Funds Separate
It is one of the key objectives of the IOLTA account to ensure that the money owned by either the clients or any other third parties is kept separate from the operating money of the law firm. The lawyer can hold the money related to the client’s business on a temporary basis; however, it does not necessarily mean that the money becomes the property of the law firm.
For instance, the client may give some advance payment for the services which are to be rendered by the lawyer at a later stage. The lawyer cannot consider the money as earned until and unless the relevant rules allow him to do so.
2. Interest Supports Legal Aid Programs
The term “interest” in IOLTA plays an important role since interest on the qualifying pooled client funds may be collected and used for access to justice programs. IOLTA programs exist in different U.S. jurisdictions, but they may have different structures and requirements.
The attorney does not treat the interest as extra income for the law firm. It all depends on the particular IOLTA program that applies to the situation. Attorneys who practice in several jurisdictions need to learn about the different requirements in each jurisdiction.
3. IOLTA Is Part of a Lawyer’s Fiduciary Responsibility
Handling money for a client is not like handling regular income for a business. Lawyers owe a duty to their clients as well as to any third party for whom they are responsible for any property and are bound to take care of the money and document everything accordingly.
This is why there needs to be a more stringent process in place for trust accounting as compared to a normal business bank account, which can tell who owns the money and for what reason and in what amounts.
Common IOLTA Account Mistakes to Avoid
Trust fund errors can have severe repercussions. While bookkeeping error need not necessarily be intentional, there could be major repercussions for a firm if it is unable to maintain proper records for client funds or comply with the appropriate conduct guidelines.
Commingling Client and Firm Funds
The most grievous error is to deposit client monies into the firm’s general account or use trust monies for general business expenses. The client monies cannot be considered income of the firm just because the firm is able to control these monies.
An advance fee which has not been earned yet normally cannot be moved from the trust account into the firm’s general account for the sake of increasing the amount of cash on hand.
Making Improper Withdrawals
All withdrawals from the IOLTA account must be for a proper and well-documented reason. A lawyer should never withdraw money from an IOLTA account and use it to pay for personal bills, office costs, or to make a temporary “loan.”
Some of the reasons for withdrawing money from a trust account could be payment to the client, payments to the third party on behalf of the client, payment of legal fees if there is no dispute about them, and other reasons according to trust-account rules.
Failing to Maintain Individual Client Ledgers
Though there may only be a single balance listed on the bank statement of a law firm for its trust account, that balance can include funds from different clients and third parties. There should be separate ledgers for each client. In the absence of such ledgers, a law firm would be able to see how much money is in its IOLTA account, but not the amount belonging to each client.
This poses a significant problem, as it is possible that a law firm might use funds of one client for paying off something to another client.
Failing to Reconcile the IOLTA Account
Periodic reconciliation is one of the key controls in trust accounting. It requires that the firm reconciles its bank account against its own trust accounting records and client ledger balances.
Three-way reconciliation entails comparing the reconciled bank account balance, the trust account records of the firm, and the total balance of the client ledger accounts. These figures should tally. Monthly three-way reconciliation is recommended by the American Bar Association as a good trust accounting procedure, but rules may vary depending on the jurisdiction. In case there is a difference, it should be immediately investigated and not postponed to the next period.
Giving Staff Too Much Unsupervised Control
Although lawyers can delegate other functions, their liability regarding the safekeeping of the client’s money cannot usually be delegated. Employees who work with deposits, payments, reconciliations, or accounting need to have proper training.
Law firms need to ensure a system of checks and balances for their trust account transactions. Employee access rights need to correspond to their duties, and lawyers need to analyze trust accounts’ transactions instead of assuming that everything is okay since the accountant does them on a daily basis.
Treating Recordkeeping as Optional
All deposits and disbursements must be adequately documented. This may include deposit tickets, bank statements, client accounts, invoices, settlement sheets, checks, EFT receipts, bills, and client accounts.
The length of time for record-keeping varies from place to place. The ABA Model Rules for Client Trust Account Records take five years after the end of the representation as an example of a retention period; however, other states may have their own requirements. Law firms must abide by the lengthiest requirement among all.
Best Practices for Managing an IOLTA Account
Adequate IOLTA control requires adherence to regular process rather than waiting for occasional audit. A law firm should incorporate trust accounting control procedures in its regular activities.
Keep Trust and Operating Accounts Completely Separate
Establish an account exclusively for trust money of qualified clients, and other accounts for the operating monies of the business. Do not make use of the IOLTA account to provide money temporarily for expenses incurred in the business.
This will enable the accounting system of the business to be able to differentiate between trust money and the operating monies.
Record Every Transaction Immediately
Do not wait until the end of the month to re-create trust account entries. Document entries such as deposits, transfers, withdrawals, and distributions by providing sufficient details to specify the client, dollar amount, date, source, payee, and purpose of the transaction.
A well-maintained record enables the firm to provide prompt response when a client requests an account of money. Furthermore, reconciliation is made easy since transactions can be tied back to documentation.
Perform Regular Three-Way Reconciliations
The bank statement must be reconciled by comparing it with the firm’s trust account journal or ledger and the balance on an individual client basis. This will ensure that the amount of money in the account is in agreement with the balance shown in the firm’s accounting records.
Monthly reconciliation is considered a best practice, although the minimum frequency under a particular jurisdiction may be lower. Any variance should be investigated and resolved and not just recorded through adjustment in the accounts so that both balances are equal.
Establish Clear Approval and Payment Procedures
Firms should establish procedures for authorizing trust-account payments. There should be proper documentation in place and appropriate authorizations given by people with the right to authorize those transactions.
Electronically transferred funds deserve special consideration, since funds can be moved swiftly through the electronic process. Proper authorization mechanisms must be set up along with record-keeping processes for any transactions done electronically. Do not use loose transaction authorization methods where it becomes hard to identify the authorizer and the purpose of the transaction.
Train and Supervise Accounting Staff
Accountants will also be able to assist in IOLTA accounting, but lawyers should not think that because an individual is experienced in the field of accounting, they know the trust-account rules that apply in their jurisdiction.
The staff needs to be educated about the processes of the firm, the client ledgers, reconciliation, payment authorizations, and record keeping. Lawyers need to examine the reports as well.
Use Specialized Trust Accounting Technology
Technology can assist in organizing the practice of trust accounting, especially for businesses which have several clients and conduct many transactions. Technology like legal accounting programs could offer features such as ledgers at client level, trust account reconciliation process, transactions history and reporting among others.
It may not be possible to use general accounting programs in the process of doing trust accounting because these programs may lack certain controls and processes that are necessary in trust accounting.
Review IOLTA Rules Regularly
The IOLTA Rules are not uniform throughout the United States. Different jurisdictions can have separate rules for the following:
- Account setup
- Eligible funds
- Reconciliation
- Recordkeeping
- Banking
- Reporting
Firms should examine the applicable rules within their jurisdiction and ensure changes are made to procedures as necessary. It should be noted that law firms working in more than one jurisdiction should not assume that a procedure allowed in one jurisdiction would be acceptable in another.
Conclusion
The use of an IOLTA account is an indispensable way of safeguarding the funds of clients and any other third parties who may entrust the law firm with their funds. The main functions of the IOLTA account include more than mere keeping of funds as it offers a systematic method of segregating funds of clients from those of the firm and facilitating access to justice programs through the interests earned on the qualifying pooled funds.
The greatest dangers arise from commingling, wrongful withdrawal, poor client ledgers, inadequate supervision, poor documentation, and lack of reconciliation of accounts. Proper planning, accurate records, regular three-way reconciliation, and employee training can greatly enhance trust account management. Since the IOLTA regulations vary according to the jurisdiction, law firms must ensure that they understand the regulations in their states rather than following general practice only.
The Fino Partners provides outsourced accounting services and bookkeeping support that can help law firms organize recurring financial processes. For firms that need assistance with bookkeeping and financial record management, professional accounting support can help maintain consistent transaction records and reconciliation workflows.
