Mismanagement of client funds is a common reason why legal professionals face disciplinary action, potentially including disbarment.
Attorneys are likely all too familiar with the terms IOLTA or IOLA account. They stand for Interest on Lawyer Trust Accounts or Interest on Lawyers Accounts and can be as complex as they are beneficial. Understanding how these accounts work can help attorneys and law firms avoid the most common mistakes, gain firm efficiency, and avoid possible penalties for not following the applicable rules and regulations.
What is the purpose of an IOLTA/IOLA account?
When money is held in trust on behalf of a client, the money can earn interest. If a large amount of interest can be earned, then an attorney may be required to set up an account on the client’s behalf.
An IOLTA/IOLA account may be more appropriate to set up if the money being held in trust on behalf of a client is:
- Too small or the holding period is too short to open an interest-bearing account on behalf of a client, or
- The transaction fees associated with setting up and administering the account would be greater than the interest generated – meaning the client would lose money.
Three-Way Reconciliation
Solo or small practice attorneys are probably familiar with three-way reconciliation, since they are required to perform reconciliation on a periodic basis depending on state rules. Attorneys at large firms may be less familiar with the process, as big firms typically have extensive staff to manage reconciliation and trust account management.
To break it down, IOLTA/IOLA account management involves reconciliation of three different balances from three different sources:
- First is the IOLTA/IOLA bank balance, sourced from an attorney’s bank statement or online banking software.
- Second is the client ledger, which records all incoming transactions to and outgoing transactions from the IOLTA/IOLA account for each individual client matter.
- Third is an attorney’s accounting book balance or trust ledger.
To reconcile, the IOLTA/IOLA bank balance should equal the sum of the individual client ledgers and the amount in the trust ledger accounting book balance. If these three balances are not equal, then there is an error in one of the ledgers, which often takes investigative work and time from the attorney to diagnose.
The attorney must review each transaction in and out of the IOLTA/IOLA account and ensure that it was recorded properly to the right client in the right amount in the client ledgers and in the trust ledger account book balance. Most likely, a transaction was entered incorrectly, assigned to the wrong client or omitted from one of the ledgers.
To make matters more complex, while most errors occur when making entries into one of the ledgers, it is also very important to account for and track uncleared or unposted transactions to the IOLTA/IOLA balance. Common examples of these types of transactions are checks written and not yet cleared from an attorney’s IOLTA/IOLA account, as well as pending deposits not yet posted to the account.
Three tips for IOLTA/IOLA Account Management
Attorneys went to school to practice law, not accounting. To streamline trust account management, simplify three-way reconciliation and make the entire process more efficient, here are three tips to keep in mind:
- Know the IOLTA/IOLA “total balance” which is typically the ending balance from the previous business day, plus or minus any transactions that posted real-time on the current day. Remember this balance typically does not account for pending transactions, or transactions initiated but not yet presented or cleared with the bank.
- Know the “available balance,” which is the amount that can be used for withdrawals, transfers and payments net of pending transactions.
- Adjust the client ledger and trust ledger to reflect the pending transactions.
As a best practice, attorneys should perform this process consistently on a periodic basis, typically monthly or quarterly, as recommended by the state. The more frequently reconciliation is performed, the better, as it is best to be prepared to respond to any client or auditor inquiries with up-to-date client ledgers that are aligned with an attorney’s bank account balance and trust ledger.
Trust accounting can be time-consuming. Every minute an attorney spends managing an IOLTA/IOLA account is a minute he or she can’t spend practicing law. At the same time, the protection and proper management of client funds is incredibly important. Mismanagement of client funds is a common reason why legal professionals face disciplinary action, potentially including disbarment.
At Nota, we’re helping attorneys manage their IOLTA/IOLA accounts by closing the loop between the bank account and the client ledger. Our mission is to help attorneys feel more organized and at peace with trust accounting. The process is complex, but it doesn’t have to be.
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