Case Study: How One IOLTA Mistake Turned Into a State Bar Inquiry

November 30th, 2025

By Marc Pamatian

When Growth Gets Complicated

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An attorney started his practice the way many solo lawyers do: as a sole proprietorship. His Social Security number was his business ID, his IOLTA trust account handled client retainers and settlements, and everything ran smoothly enough.

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As the business became more profitable, his CPA suggested forming an S corporation to better manage taxable income. It seemed like a reasonable move with new tools for payroll, more options for deductions, and cleaner separation between business and personal finances. He filed the new corporation, obtained an EIN, opened new bank accounts, and, following that same advice, opened a new IOLTA trust account under the corporation’s name. That is when things took a turn.

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A New Entity, a Hidden Problem

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What he did not realize was that this was not just a structural upgrade. It was an entirely new legal entity. He thought of it as a continuation of his old practice, just more formalized. The same office, same name, same clients. It all looked the same from the outside. But legally, the S corporation and the sole proprietorship were two different people.

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When he transferred all of the client funds from the old IOLTA into the new one, zeroing out the balance, he believed he was simply moving the firm. In reality, he had just transferred client trust funds from one legal entity to another. The clients’ money was now sitting in a trust account belonging to an entity they never engaged with.

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How the State Bar Found Out

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A few months later, one of his former clients cashed a settlement check that had been drawn on the old IOLTA. The problem was that account had been emptied. The check bounced.

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Most attorneys do not realize this, but financial institutions that hold IOLTA accounts are required to notify the State Bar if a trust check bounces or if an account is overdrawn. It is an automatic compliance trigger.

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That notification started the audit. When the Bar looked at the records, they saw a zero balance in the original IOLTA. The attorney explained that he had moved the funds into the new IOLTA under his corporation. To him, nothing was wrong since the money was still there. But to the Bar, that statement only made things worse.

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Because the clients were still engaged under the old business, the fiduciary responsibility remained there. Moving their funds to a trust account owned by a different entity violated the separation rules that keep client money protected. The Bar saw no evidence of intent to mislead or misuse funds, but intent does not matter much in trust accounting. What mattered was that the record did not line up with the entity that held the clients’ agreements.

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When Fixing It Gets Complicated

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Once the Bar got involved, the directive was clear: the funds needed to be returned to the proper entity’s trust account. But that was easier said than done. By that time, several client matters had already been closed, and settlement disbursements had been issued from the new IOLTA. Those transactions could not be reversed. You cannot recall a settlement check.

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So, from an accounting standpoint, the solution was not to undo history. It was to document it. The correct approach was to treat the funds as intercompany activity. The S corporation had effectively paid the sole proprietor’s client obligations, so the bookkeeping had to reflect that. On the sole proprietorship’s books, a due to S-Corp account was created. On the corporation’s books, a matching due from Sole Prop account appeared. The relationship between the two entities was now documented as a loan to cover those obligations. This intercompany adjustment did not make the original mistake disappear, but it told the truth. It showed where the money went, which clients were paid, and which entity technically covered the expense. The books aligned again, and the Bar’s reviewers could follow the trail without any missing links.

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What the Bar Really Looks For

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At its core, the State Bar is not looking for perfection. It is looking for integrity of records. They want to know that a lawyer can prove three things:

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1. Whose money it is.

2. Where it is being held.

3. That every transaction has documentation to back it up.

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Once the reconciliations were rebuilt, the ledgers balanced, and every client matter tied to the right account, the Bar was satisfied. It took time, cooperation, and detailed intercompany adjustments, but the story ended cleanly. And that is really what bookkeeping is about. Not just accuracy, but clarity. Mistakes happen, but a clear and complete record can explain them better than any excuse.

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Why Every Law Firm Needs Alignment

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The real lesson from this case is not just about compliance. It is about communication. Law firm accounting is a team effort between three people:

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• The attorney, who understands the client flow and case timelines.

• The CPA, who manages tax structure and filings.

• The bookkeeper, who maintains the financial records and monthly reconciliations.

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Each one sees a different part of the same system. And when those perspectives do not align, even a small misunderstanding can spiral into a major compliance issue. Someone on that team needs to understand how IOLTA funds are supposed to move:

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• How client funds are deposited.

• How disbursements are approved.

• How the three-way reconciliation ties it all together.

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That is the knowledge gap that turns growth into risk. When your firm grows, your trust accounting has to grow too. Because a new entity does not replace your obligations. It just gives them a new name.