In this guide, we'll go over exactly what an IOLTA account is, how it works, and look at some common ways lawyers mishandle them.
What is IOLTA?
Whenever a law firm holds on to a client's money, they hold those funds in a trust. But if the amount of money is small, law firms will usually pool together smaller amounts into one big checking account.
Before IOLTA came along in 1981, law firms were required by federal law to deposit these funds into a non-interest bearing checking account. This is because lawyers can't benefit financially from their clients' money.
IOLTA changed this by allowing law firms to place these funds into an interest-bearing trust account instead.
The interest rate of lawyers' trust accounts generates funds for the state IOLTA board, which uses those client funds to finance activity like:
- Civil legal services
- Improving the administration of justice
- Paying for legal aid for low-income and underserved residents
- Funding law school scholarship programs
- Providing legal assistance to those that can't afford it
- Funding grants for non-profit organizations and public service programs
Is IOLTA available in my state?
Every state has an IOLTA program, and it's likely that the financial institution where you opened your regular business checking account also offers IOLTA accounts.
While each IOLTA program follows similar guidelines, rules do vary by state. For example, state Supreme Courts have made IOLTA mandatory in some states and voluntary in others. That's why it's important to consult your state Bar Association and a professional accountant before finalizing your accounting setup for IOLTA.
An example of IOLTA accounting in action
Let's imagine that your law firm has agreed to provide legal services to Doris, a local orthodontist, representing her in a lawsuit. Doris sends you a $5,000 check to cover your retainer fee, which you deposit into Doris' client trust account.
Regardless of how your law firm does its accounting, the system that you use to keep track of an IOLTA account must conform to the principles of double-entry accounting.
No matter which accounting solution you use, you should keep a separate ledger for each individual client account, even if it's small or for a short period of time. Here's what Doris' individual ledger would look like after the transaction we mentioned above.
Doris’ account ledger, after depositing a $5,000 retainer check
Let's say on that same day, your firm completes four hours of work on Doris' file, at a rate of $100/hr. That means your firm can withdraw $400 from Doris' IOLTA account and transfer it into your firm's business account.
After invoicing Doris for $400 and giving her a chance to review the fee (fees should only be removed from an IOLTA account after client approval), Doris' ledger would now look like this:
Doris’ account ledger, after invoicing her for $400
If these entries are recorded correctly, all credits and debits should cancel each other out, like the above example.
Professional bookkeepers can be an essential support for law firms that need to make sure their IOLTAs are always accurate and up-to-date. They can also flag any potential misuse of trust funds so that they can be fixed before you face any penalties. Bench works with many law firms and is experienced in handling all aspects of law firm bookkeeping—including IOLTA accounts. Your books will be ready for tax season and you can work confidently knowing your IOLTA account is handled right. Learn more about how Bench can help you today.
Five common mistakes that lawyers make with IOLTA
1. Borrowing money from an IOLTA
Lawyers may not under any circumstances withdraw fees from an IOLTA account before earning those fees. This is sometimes referred to as “borrowing,” and attorneys do it for many reasons: because they have short-term cash flow problems due to unexpected expenses, or simply because they've told themselves they'll replace the funds right away.
Whatever the reason, borrowing from an IOLTA account carries stiff penalties, regardless of which state you’re in. These can include accusations of misappropriation of funds as well as disciplinary action by your state’s Bar Association. Borrowing money from an IOLTA is also one of the most common ways to get disbarred.
2. Failing to keep your client and business accounts separate
Trust funds need to be sacred—for the client's account only.
You can't, for example, pay for your firm's operating expenses directly out of an IOLTA account. You'd need to move those funds into a business account first.
Note: if your bank issues a debit card for your IOLTA account, under no circumstances should it have ATM privileges. Your state Bar Association will typically have a list of recommended banks that offer IOLTA accounts, but some nationwide options are M&T Bank, Chase, and Citibank.
Some firms will also intentionally use their IOLTA accounts to hide assets, or will leave funds in their IOLTA even after they've been earned, using it as a “savings” account.
Regardless of which state you're in, you cannot, under any circumstances, use an IOLTA account as a savings account or an operating account, even if the money you withdraw from the IOLTA has already been earned.
3. Charging clients for payment fees
If you've made the switch from paper checks to electronic billing (e-transfer, credit card payments, or other types of payments), you can't pass along the payment fees to your client's IOLTA.
Some IOLTA-friendly merchants (like LawPay) will charge fees to your firm's operating account while depositing funds to the IOLTA account. If your merchant isn't IOLTA-friendly, however, these fees can become hard to track, causing you to charge the wrong client's account.
To prevent misappropriating funds from other clients, remember to only charge your clients for fees directly relating to their trust account. Your client does share some responsibility for this
4. Recording a trust deposit as "income"
Some firms find it tempting to record a trust deposit as income in their accounting software, for simplicity's sake. But they shouldn't.
The funds deposited in your client's accounts don't belong to you—in fact, they are funds you owe your clients. Recording them as anything but that could land you in hot water with regulators and mess up your taxes.
5. Bad recordkeeping
Let's say that one day you discover a small shortfall in your IOLTA account, and you can't account for how it got there.
“If the amount is small enough, it shouldn't matter,” you think to yourself.
“Right?”
Not quite.
Every single transaction in and out of your IOLTA must be accounted for, no matter how small. And you should be able to supply accurate and up-to-date records for all of your trust accounts—not just IOLTA—to the state bar upon request.
Failing to keep good records for each client's account—by forgetting to write your client's reference number on their trust account checks, not keeping a separate ledger for each client, or simply by misplacing a record—is bad professional conduct, and another common way that attorneys break IOLTA rules.
Your state bar association requires you to be able to show how much money each client has in their account at any given point in time. If your records can't show that, you need to correct them.
So you've mismanaged your IOLTA—what do you do?
First, contact a practice management advisor in your state. These consultants usually have experience dealing with IOLTA, and rules in most states don't require them to report ethics violations to the bar.
If you're just starting out and think you've set up your accounting the wrong way, talk to a professional accountant with experience dealing with IOLTA.
If you don't have time to manage your own bookkeeping and are thinking of hiring outside help, make sure to hire a bookkeeper who has experience with law firms.
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