What is an IOLTA account?
IOLTA is an acronym for Interest on Lawyer Trust Accounts. It simply describes a type of trust account designed to keep client funds in trust. Holding client funds in trust is a requirement of the professional conduct rules, although in some states it is voluntary. Interest that is earned on IOLTA accounts is directed to the lawyer’s trust fund, which usually uses those funds to support legal aid programs, but this might vary from state to state. The law firm can find many financial institutions that are allowed to provide IOLTA accounts in the state they operate in.
When you should use an IOLTA account?
According to the Rule of Professional Conduct 1.5, lawyers much hold client funds in one of two types of client trust accounts – the first is an IOLTA account and the second is a separate non-IOLTA trust account created for the benefit of an individual client. In both cases, the client trust account must be an interest-bearing account. This requirement was established in 1983. However, in neither case may a lawyer collect interest that is earned on that account because it is not their money that is in the bank account.
According to paragraph F of the rule, an IOLTA account is to be used for the deposit of client funds that are nominal in amount or to be held for a short period of time. In many cases, this describes funds such as security retainer payments or settlement amounts that will soon be distributed among several parties, including the client, the lawyers as a fee, and then any lien holders, such as medical providers or expert witnesses.
IOLTA account process
Merchant processing is very similar whether you are a medical practice, a dry cleaner, a restaurant, a B2B, or a mail-order company. Law practices are quite different in one regard – there is an Operating account and a Trust account. So, at law firms, the process would look something like this:
- The money must go into the Trust account.
- The fees come out of the Operating Account, whether on a daily or monthly basis.
- Then, the law firm must, according to their own cash management, transfer money from the Trust account to the Operating account.
When it comes to accounting for this money, we would need to cross out the option to record them as interest income and interest expense right away, because it is not one or the other. There are several ways one can keep a record of these funds and one of them is creating an Interest Payable account. This way your Profit and Loss will not be affected and you will just have a record in your accounting books without zero effect on the balance.
Let’s summarize everything above, so you have a clear image of what the basic compliance requirements are.
- Every firm must have an IOLTA account to receive funds from clients and also disperse those funds.
- When fees are earned, those funds are then transferred and deposited into a separate checking account, which might be referred to as an Operating account.
- Your firm must have a clear and compliant accounting process in place for all records around funds received and spent, including knowing which money belong to which client.
Do you have a clear accounting process in place to track all the records regarding clients’ money as well as all money earned and spent by the firm? The ethical and fiduciary responsibility is not only to your clients but to the entire firm’s process and recordkeeping around money. If you have a hard time understanding the IOLTA rules in your particular state or simply do not have time for that, it is recommended that you have an accountant take care of your financial records.
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Author: Charles Lutwidge