In a recent audit, over 50% of lawyers admitted they struggle with properly maintaining and reconciling client trust accounts. This makes sense because trust accounting isn’t just another law firm bookkeeping task; it’s a complex process requiring strict compliance with state bar regulations. Every transaction must be carefully recorded, funds must be kept separate from operating accounts, and monthly reconciliations are essential to ensure accuracy.
And while most attorneys would never intentionally mishandle client funds, simple bookkeeping errors like recording a transaction incorrectly or withdrawing funds too soon can still lead to compliance headaches. In some cases, firms only realize an issue when they’re audited or when a client raises concerns.
At its core, trust accounting is about keeping client funds separate and ensuring they are handled with complete transparency. However, that’s there’s a lot more to it. Let’s break it all down so that by the end of this blog, you understand everything you need to know about trust accounting.
What Is Trust Accounting?
Trust accounting is how law firms manage and track client funds held in trust. This money doesn’t belong to the firm, at least not yet. Instead, it sits in a separate account until it’s earned or used for client-related expenses.
Here are some examples of what goes into a trust account:
- Retainers – Upfront fees from clients that remain untouched until legal services are rendered.
- Settlement funds – Money won in a case that needs to be properly disbursed.
- Court fees and advanced costs – Funds set aside for expenses like expert witness fees or court filings.
- Disputed funds – Any amount under dispute between a client and the firm that must stay put until resolved.
Types of Accounts in Law Firm Bookkeeping
Law firms typically manage three main types of accounts. Keeping them separate is non-negotiable.
1. Operating Account
This is your firm’s day-to-day bank account for business expenses like payroll, rent, and office supplies. Client funds should never touch this account until they’re earned, meaning that the law firm has completed the agreed-upon legal work and is entitled to the payment under the terms of the client agreement.
2. Client Trust Account
This is where client money is deposited until it’s earned or needs to be disbursed for case-related expenses.
3. IOLTA Account (Interest on Lawyers’ Trust Accounts)
Some states require law firms to deposit small or short-term client funds into an IOLTA account. These accounts are designed to pool client funds that aren’t large enough or won’t be held long enough to generate meaningful interest for the client.
Instead of sitting idle, the interest earned on these accounts is collected by the state and used to fund legal aid programs, supporting access to justice for those who can’t afford legal representation.
However, you’re still responsible for ensuring proper record-keeping, compliance with state bar rules, and regular reconciliations. If you’re handling client money, make sure you know whether your state requires an IOLTA account.
The Golden Rules of Trust Accounting
Bookkeeping for law firms comes with strict rules to ensure client money is protected, transactions are transparent, and firms stay compliant with state bar regulations.
To keep your trust accounts in order and your firm out of trouble, follow these golden rules.
1. Keep Client Funds 100% Separate
One of the biggest don’ts in bookkeeping for law firms is commingling funds — mixing client trust funds with firm money. Even if it’s by accident, it’s still a major violation.
- DO deposit client retainers directly into the trust account.
- DO NOT use the trust account to cover firm expenses, even if the intention is to borrow the funds temporarily and replace them later.
Even if your firm is facing cash flow issues, trust funds can never be used as a financial buffer. Doing so, even with the best intentions, is considered a misappropriation of client funds, which can lead to severe disciplinary action, including fines, suspension, or disbarment.
2. Only Use Trust Funds When They’re Earned
You can’t withdraw client funds until you’ve earned them.
For example, if a client pays a retainer upfront, those funds remain in the trust account until legal services are provided. The firm can only withdraw the amount that corresponds to completed work based on a detailed invoice.
To stay compliant, you must ensure that every withdrawal is supported by proper documentation and clear accounting records before transferring funds from a trust account to an operating account.
3. Perform Three-Way Reconciliations (Every Single Month!)
Skipping trust account reconciliations is a disaster waiting to happen. Every month, make sure these three records match:
- Bank statement — what the bank says you have in trust
- Trust ledger — what your firm’s accounting records show as the total balance of all client funds held in trust.
- Client ledgers — a detailed breakdown of how much money belongs to each individual client, ensuring that the total of all client-specific balances equals the trust account balance.
If any of these don’t match, you need to figure out why. It could be due to:
- Bank fees or interest adjustments – Some banks charge monthly fees or apply interest that isn’t automatically recorded in your books.
- Data entry errors – A simple mistake, like transposing numbers or recording a deposit under the wrong client, can throw off your records.
- Outstanding checks or deposits – Funds that have been recorded but haven’t cleared the bank yet can create temporary discrepancies.
- Improper withdrawals – Accidentally pulling funds too soon or taking money from the wrong client’s balance can lead to trust accounting violations.
- Unrecorded transactions – Payments, refunds, or client disbursements that weren’t logged properly in the trust or client ledgers can cause mismatched balances.
The sooner you identify and correct discrepancies, the better.
4. Keep Detailed Records (and Don’t Throw Them Out Too Soon)
Every dollar that moves in or out of a trust account needs a paper trail. If you ever need to prove where client funds went, you don’t want to be scrambling for missing details. Every deposit, withdrawal, and transfer should include:
- Dates – The exact date the money was received, withdrawn, or transferred.
- Amounts – The precise dollar amount to the cent.
- Client names – Who the money belongs to or who it was paid to.
- Descriptions of the transaction – A clear note on why the money was moved (e.g., retainer deposit, settlement payout, court fee).
Most state bar associations require that you need to hold onto these records for at least five years (or longer, depending on your state). If an audit happens or a client questions a transaction, you need to be able to pull up the details fast.
Trust Accounting Best Practices
If you want to stay compliant with trust accounting rules and avoid unnecessary headaches, follow these best practices:
- Use trust accounting software – Manually tracking trust funds can lead to mistakes, and spreadsheets won’t cut it if you’re managing multiple clients. Legal-specific software like Clio, TrustBooks, and PracticePanther helps automate record-keeping, track transactions, and ensure compliance with state bar regulations. Expert bookkeepers use accounting software to provide bookkeeping services for law firms.
- Establish internal trust account policies – Clearly define who in your firm is responsible for managing trust funds and how transactions are processed. Set rules for depositing retainers, approving withdrawals, reconciling accounts, and handling client refunds to ensure everyone follows the same procedures.
- Be transparent with clients – Clients have the right to know where their money is and how it’s being used. Providing regular trust account statements builds trust and ensures clear communication. If a client requests details about their funds, you should be able to provide a complete breakdown immediately.
- Train your team well – The more informed your team is, the less likely costly mistakes will happen. Hold regular training sessions to go over state bar regulations, reconciliation procedures, and record-keeping requirements. Consider assigning a dedicated team member to oversee trust transactions and review compliance on a routine basis.
- Outsource to an expert – If trust accounting feels too complicated or your firm lacks time to manage it properly, consider outsourcing your law firm’s bookkeeping to a professional agency like CoCountant, which specializes in legal trust accounting and compliance. This can help save time and reduce risk.
Final Takeaway
Trust accounting is crucial to law firm bookkeeping, which ensures client funds are properly managed and that businesses remain compliant with legal and ethical regulations. Get it right, and you’ll protect your clients, firm, and career. Mistakes in handling client funds can lead to legal trouble, fines, or even loss of licensure.
Keeping funds separate, reconciling regularly, and maintaining detailed records are essential for protecting both your practice and reputation. With the right systems in place, law firms can stay compliant and avoid costly fines or penalties.