What Are IOLTA Accounts And How To Handle Them
Law firms have to follow very strict rules concerning how client funds are handled, where the money is kept, and when it can be used. While the exact rules vary slightly between state bar associations, all lawyers are required to keep unearned client funds in a separate trust account, commonly called an IOLTA, meaning “Interest on Lawyer Trust Account”. Despite the fact that mismanaging or commingling money in an IOLTA can result in a reprimand or even disbarment in more extreme cases, many attorneys still only have a fuzzy grasp on how to properly manage them.
Legal accounting is notoriously tricky and, truthfully, not enough time is spent training attorneys on the various intricacies that go into correctly managing their finances. But in the end, mishandling an IOLTA trust account, even as the result of an honest mistake, can irrevocably damage your reputation and erode client trust. In short, you should never make assumptions or take chances when it comes to handling your client’s funds.
By taking the extra time to understand what an IOLTA is, best practices, and the available tools for managing them - your law firm can ensure perfect compliance and spend more time focusing on serving your clients.
What is an IOLTA Account?
An IOLTA - sometimes called an IOLA - is an interest-earning trust account that is specifically used to hold money that belongs to a legal professional’s clients. Using a trust account to handle things like retainers, settlement checks, and court fees ensures that the client's money is kept separate from the professional’s business account. In other words, unearned money held in an IOLTA account cannot be used for operating expenses, or a lawyer’s personal expenses. Additionally, to maintain ethical and legal standards, attorneys cannot profit off of any interest generated by these accounts.
Theoretically, if a law firm handles a particularly high volume of money for a single client, they may opt to set up a separate attorney trust account that can earn interest for that client’s benefit alone. However, in most cases, individual client payments are too small or held for such short amounts of time that setting up and administering individual trust accounts is impractical.
IOLTA programs were established in the early 1980’s to give lawyers a way to pool smaller payments and short-term funds from multiple clients into a single, interest-earning trust. Before IOLTAs, law firms had to hold any combined client funds in special checking accounts that could not earn interest. Instead of earning interest on the client’s behalf, the interest from an IOLTA account is funneled to state bar associations to fund legal assistance for low-income clients and other charitable causes. Over the years, IOLTA programs have funded many beneficial community legal programs, legal aid offices, and pro-bono work.
When is an IOLTA Account Used?
Any time a law firm accepts payments for retainers from clients or handles money on a client’s behalf, it is put into an IOLTA. Legal fees that are not part of a retainer can generally go directly into an operating account, since the payment is not for future work. While any unearned client money is required to be deposited into a trust, it may or may not be mandatory to use an IOLTA, depending on the rules in your state. To confirm whether or not using them is required, it’s best to check in directly with your state bar association or a legal account expert. That said, given that an IOLTA raises money for a number of worthy causes, it’s almost always beneficial to use them.
How Do IOLTA Accounts Work?
To best understand how an IOLTA is used on a practical level, let’s run through a basic example.
After signing a retainer agreement, Client A pays you a $7,000 retainer fee to secure your services for an upcoming lawsuit. Importantly, at this point, the money for the retainer is put into trust because it does not yet belong to the law firm, and is therefore considered “unearned”. Instead, the money is set aside and inaccessible until after work for that client is completed.
After a week, you begin work on Client A’s case at an hourly rate of $120/hr. In total, you spend 4 hours on the case and bill Client A $480. Even though work has been technically completed, you still cannot take any money directly from Client A’s retainer until they review and approve the billed amount. Then, once approved by Client A, the $480 is considered earned but cannot be withdrawn directly from the IOLTA account. Instead, the money is then transferred to the firm’s business account, while the remaining $6,520 from the retainer remains in trust.
Tips for Handling IOLTA Accounts
While this all may seem simple enough on paper, in practice, properly handling an IOLTA can be incredibly complex and time consuming. There are strict rules for how the money in them must be used and recorded. Even a large law firm with a dedicated accounting team has to take deliberate steps to maintain IOLTA compliance. Smaller law firms or independent attorneys have to be infinitely more careful, since small mistakes can have dire consequences. It’s also worth noting that a lawyer is always on the hook for misusing funds from an IOLTA, even if the mistake is made by a bookkeeper or paralegal.
Here are several accounting best-practices to keep in mind so you always handle an IOLTA trust account properly:
Keep Separate Business and Client Accounts
Commingling funds from a law firm’s operating account and a client trust fund is strictly prohibited by state ethics rules. This is why it’s essential for law firms to maintain separate operating and trust accounts. Sometimes the distinction can be confusing since completed work is paid out from funds that are held in an IOLTA. So what exactly do we mean by “commingling funds”?
- “Borrowing” from client funds: An IOLTA or any other kind of client trust account is not a savings account. Sometimes, law firms find themselves faced with impending bills and other big expenses before completing billable work and it can be tempting to draw from retainer money to stay afloat. But this kind of “borrowing”, even if you have every intention of quickly paying it back, can have serious consequences. Until work is properly completed and billed, retainer money is off limits.
Additionally, even if client funds are billed and earned, the money must be transferred to the business account first before being withdrawn. Should an IOLTA account issue a debit card, be very careful it is not used to withdraw money directly for the account in those circumstances.
Depositing client funds into a business account: Sometimes attorneys are unsure of what funds are meant to go into trust and which aren’t. If a client without a retainer pays attorney fees, for example, that money may be able to go directly into an operating account. But what if a client pays fees for an attorney’s services and court filing fees together? Even if the filing fees are miniscule, the entire amount would have to be deposited into an IOLTA first.
Charging payment fees to an IOLTA: Money from an IOLTA cannot be used to pay for third-party processing fees or charges for electronic payments. This also includes any fees to maintain the trust account itself. Instead, these charges must be taken out of the operating account. Without specialized tools and software, these mistakes can be surprisingly easy to miss.
Keeping business and trust accounts separate is simply the only way to reduce your IOLTA compliance risk. However, as many state bar associations have specific requirements for establishing and administering IOLTAs and other legal trust accounts, it’s always best to consult an expert.
Keep Detailed and Up-To-Date Records
One of the most common ways that law firms run into trouble is by not keeping detailed records of every single client’s trust account transactions. That means maintaining separate ledgers for each client and keeping track of all payments, no matter how tiny or insignificant they may seem. Additionally, IOLTA transactions should be recorded the moment they happen to avoid anything from slipping through the cracks.
To further prevent any errors, IOLTA debits and credits should be recorded using a double-entry accounting system. While keeping track of this manually can be a logistical nightmare, legal billing software can significantly streamline and simplify the process.
Deposit Checks Immediately
Related to the point above, attorneys must always have an accurate and up-to-date record where client’s funds are at any given time. While an increasing number of law firms accept payment electronically these days, some clients still prefer to pay by check. In those cases, don’t wait to deposit it. Ultimately, a client’s retainer check is not yet your money, and that money must be immediately accessible to them.
Ensure IOLTA Account Compliance with LawPay
IOLTA accounts are a useful way to keep client funds separate from a law firm’s operating expenses, all while benefiting the community. However, as previously mentioned, trying to administer them manually using spreadsheets, or non-specialized accounting software can open you up to risk. This gets even more complex as more law firms modernize by offering digital payments for their clients, since even small payment processing fees have to be handled correctly to stay IOLTA compliant.
Luckily, legal billing software like LawPay takes the complexity out of record keeping and IOLTA compliance. LawPay’s industry-leading payment solution was created in cooperation with bar associations and ethics committees to ensure all types of payments are processed correctly and in compliance with the IOLTA guidelines in your state. A variety of powerful, best-in-class features help you easily manage your client trust and streamline your payment processes:
Automatic Separation of Earned and Unearned Funds: LawPay connects to both your trust and operating accounts, ensuring your earned and unearned funds remain separate. Strict payment processing rules take the guesswork out of account management, as funds are automatically moved into the correct accounts.
Streamlined Record Keeping: Unintentional gaps in your records can snowball into big problems down the line. LawPay drastically simplifies record keeping by making relevant and detailed notes of every transaction. Multiple trust and IOLTA accounts can be linked into LawPay’s system, giving you a comprehensive and consistent way to track client funds and operating costs in real time.
Compliant Payment Processing Practices: As we’ve discussed, payment processing fees, including those by third parties, cannot be taken from a trust account. LawPay strictly prohibits debits from your trust account for any reason, and all processing fees are automatically tracked and debited from your operating account at the end of the month.
Improve Compliance With Existing Software: With robust integrations with most of the leading legal operations and accounting software, LawPay adds an additional layer of security to your existing processes.
Ready to Learn More?
When it comes to effectively managing an IOLTA account, your law firm can’t afford to take risks. Contact us today to find out how LawPay can help you manage your trust accounts, minimize compliance risk, and give you more time to focus on your clients.