Did you know that trust accounting errors are among the most common reasons lawyers face disciplinary actions? Comingling of trust account funds and other trust funds is the most prevalent.
Managing attorney trust accounts starts with setting them up correctly for each client and ensuring that funds are only withdrawn when earned. With each state (and sometimes counties) imposing specific rules, law firms need to stay well-informed of their jurisdiction’s requirements to avoid legal trouble.
In this blog, we’ll provide an overview of the ABA’s Model Rules on Client Trust Account Records[1] to help guide you through best law firm bookkeeping practices. Be sure to also check your local Bar Association[2]for any region-specific rules and regulations.
1- Accessing client funds before they are earned
Lawyers must adhere to strict guidelines when handling client trust funds, and one of the key rules is that funds in trust accounts can only be accessed when they are earned. This means that money should only be withdrawn for billable work or to cover expenses incurred on behalf of the client, such as court fees. For instance, after completing legal services for a client, a lawyer can transfer the earned funds from the trust account to the firm’s operating account.
To prevent any misuse of client funds, it’s essential to set up strong law firm bookkeeping procedures. Consider implementing systems that require signed invoices or other forms of documentation before funds are moved from the trust account. This provides a safeguard against accidental or improper use of client money.
In some states, lawyers may not need to use trust accounts for small amounts of client funds, depending on the specific rules of the state bar association. However, before opting for this, always consult your local state bar to ensure you’re in compliance with regional regulations.
2- Commingling the funds
Keeping client trust funds separate from your law firm’s operating funds is a fundamental rule in trust accounting. Commingling funds—mixing client money with the firm’s money—can lead to serious ethical violations. To prevent this, it’s essential to ensure that client funds are held in a dedicated trust account and are only used for specific client expenses.
One simple way to avoid commingling is to store all physical client trust checks and deposit slips in a separate location from your firm’s operating account checks. This creates a physical barrier that minimizes the risk of accidental mixing.
Another important step is to maintain a detailed legal chart of accounts. For example, client funds should never be reported as income until the work has been completed and the funds have been earned. A well-organized chart of accounts helps ensure that all transactions are properly categorized, keeping client funds distinct and maintaining compliance with ethical standards.
3- Overlooking recordkeeping for check conversions
According to the ABA, law firm bookkeeping must maintain detailed records of certain types of check conversions, ensuring transparency and compliance. Below are the most common types of check conversions that require proper documentation:
- Point-of-purchase conversion: This occurs when a firm converts a paper check into an electronic debit at the time of a transaction. After the conversion, the paper check must be returned to the client or issuer.
- Back-office conversion: In this scenario, a paper check is converted to an electronic debit after it has been received at the point of purchase. Once the conversion is complete, the firm is responsible for securely destroying the paper check.
- Accounts-receivable conversion: This type involves converting a paper check into an electronic debit when processing payments for accounts receivable. The paper check is destroyed once it has been successfully converted.
- Telephone-initiated debit (check-by-phone): This occurs when clients provide their bank information over the phone, allowing the firm to convert the check to an electronic debit.
- Web-initiated debit: This is when a client initiates an electronic payment through an online platform, converting the payment into a debit.
4- Leaving records incomplete
To ensure compliance with trust accounting regulations, it’s crucial for law firms to maintain thorough and accurate records for all client trust activity. This includes accurate law firm bookkeeping and setting up specific accounting ledgers to track client trust balances, deposits, withdrawals, and related transactions.
The ABA’s Rule 1 provides guidelines for the types of records that need to be maintained, which include:
- Trust account ledger: Records of all deposits and withdrawals, including dates, sources of funds, purposes, and detailed descriptions of each transaction. For withdrawals, the ledger should also include the payee information.
- Client-specific ledgers: Each client with funds in a trust account should have their own ledger detailing their name, deposits, disbursements, and transaction descriptions. It should also track the source of deposits and the recipients of disbursements.
- Electronic transfer records: For electronic transfers, law firms should document the name of the individual authorizing the transfer, the recipient, and confirmation from the bank that the transaction was completed.
- Routine reconciliations: Copies of routine trial balances and reconciliations should be maintained to ensure accuracy in trust account management.
- Supporting documentation: This includes bank statements, checkbook registers, canceled checks, and other financial records such as compensation agreements, client bills, and disbursement records.
Maintaining these records ensures compliance, enhances transparency, and helps manage cash flow. Clear and accurate law firm bookkeeping makes it easier to share information with clients and demonstrate proper use of their funds.
Additionally, come tax time, having organized records will simplify the tax filing process, ensuring you can report your firm’s finances accurately and avoid any potential issues with the IRS.
You should also request monthly trust account statements from your bank to verify that all account activity matches your internal ledgers, ensuring consistency and accuracy in trust account management.
5- Skipping quarterly (or monthly) reconciliations
The ABA’s model rules recommend that law firms reconcile their trust accounts at least quarterly—though monthly reconciliations are ideal for maintaining accuracy and compliance. Regularly reviewing trust accounts helps law firms stay compliant while ensuring that all financial records are accurate.
One crucial part of trust accounting is three-way reconciliation. It ensures that the balances in your bank account, trust ledgers, and accounting system match up.
Here’s how three-way reconciliation works:
- Bank statement reconciliation: Start by comparing the ending balance on your bank statement with the trust account balance, adjusting for any in-transit transactions, such as deposits or checks that haven’t cleared yet.
- Trust bank account balance: Compare the trust account balance in your accounting system to the reconciled bank statement. This ensures that your internal records align with what’s shown by the bank.
- Individual client trust ledgers: The total balance of all individual client trust ledgers must match the trust account’s total balance. This is especially important if you use the customer method, where each client’s funds are tracked within a single-parent trust account.
The key is to know to the penny what funds belong to each client in the trust account. The Bar Association will require proof that you can account for every dollar, ensuring the accuracy and integrity of your trust accounting.
6- Disposing of records too soon
The ABA requires law firms to retain client trust account records for five years after the conclusion of legal services. Failing to maintain these records can lead to compliance issues and make it difficult to resolve any disputes that arise after a case is closed.
Maintaining these records for the required period not only ensures compliance with the ABA’s rules but also helps your firm address any issues from previous clients and verify discrepancies that may come up long after the case is completed.
The bottom line
When we talk about avoiding trust accounting mistakes, we don’t mean it just for the sake of following the rules. In fact, it’s all about protecting your firm’s reputation and financial health. Errors like accessing client funds prematurely or failing to reconcile accounts on time can have far-reaching consequences, including penalties, lost trust, and damage to your firm’s standing with the Bar.
But as a lawyer, your priority is serving your clients and managing your firm. So, how do you maintain compliance with trust account regulations?
With CoCountant.
Our team of expert bookkeepers and accountants understands the specific needs of law firm bookkeeping and ensures your trust accounts are accurate and compliant. We manage everything—from ensuring funds are properly separated to conducting regular reconciliations, making sure every dollar is where it should be.
With CoCountant managing your trust accounts, you can focus on your legal practice while we ensure your firm’s financials remain compliant, protected, and audit-ready.
