Law Firm Bookkeeping

IOLTA stands for Interest on Lawyers Trust Accounts, a type of bank account attorneys use to hold client funds until they are ready to be disbursed.

These are not the headline-grabbing mistakes that make national news. They are the bookkeeping ones.

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If you are running a law firm, whether as the lead attorney or managing partner, you already know that IOLTA compliance is not optional. Every attorney must attest to it annually. It is not a suggestion; an attorney’s license depends on following the Rules of Professional Conduct that govern the handling of client trust accounts.

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Most IOLTA problems do not come from bad intent. They start with small misunderstandings that quietly compound over time. Every attorney I have met is smart, capable, and deeply committed to their work, but it makes sense that not all are accountants. A lawyer’s world is complex enough without wearing the hat of another profession.

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Below are five of the most common IOLTA bookkeeping mistakes we have seen in California law firms and how to avoid them before they turn into compliance issues.

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1. Not Performing a 3-Way IOLTA Reconciliation Monthly

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This is the most common issue we see. Many firms reconcile their IOLTA bank statement each month by comparing the balance to what appears in QuickBooks and assuming that is enough. But that is only one part of the process.

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A true three-way reconciliation compares three things:

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• The IOLTA bank balance

• The total of all individual client ledgers

• The IOLTA liability account inside your books

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All three must match exactly, to the penny, every month. If they do not, it means someone’s money is off somewhere. Maybe a transfer posted late. Maybe a check cleared under the wrong matter. Until you trace it, you are technically out of compliance.

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Under California Rules of Professional Conduct 1.15, this is not just good practice; it is a requirement. Most bookkeepers and accountants are not naturally trained in these standards. Continuing education in IOLTA compliance is essential for anyone handling a law firm’s books.

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2. Using the IOLTA to Pay for Case Costs Before a Matter Settles

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This mistake is common and deceptively innocent. A firm covers filing fees, expert costs, or transcripts out of the IOLTA, planning to reimburse itself once settlement funds clear. The problem is that unless those funds were specifically deposited for that client’s expense and the ledger reflects it, you are spending one client’s money on another client’s case. That is the definition of commingling, even when there was no bad intent.

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The rule is simple: client money stays in IOLTA until earned, invoiced, and properly transferred. Firm money, including advanced costs, should come out of your operating account or, more commonly, a firm credit card.

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If you front costs, let the business pay for them first and reimburse once the settlement funds arrive. It is cleaner, easier to defend, and avoids the gray zone of “we meant to pay it back.”

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3. Not Consulting Your Bank When a Deposit Is Too Large for an IOLTA

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IOLTA accounts are designed for funds that are nominal in amount or held short-term. The pooled interest from these accounts goes to the State Bar Foundation.

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But when a single deposit is very large or will be held for a long period, such as a major settlement or real estate escrow, that interest may belong to the client.

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In California, you are expected to consult with your bank in those situations. If the funds are large enough to generate meaningful interest, they may need to be placed in a separate, interest-bearing trust account for that client’s benefit.

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Leaving it in the pooled IOLTA can result in misdirected funds. Putting it in the operating account is worse.

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It is an easy fix. When in doubt, call your bank’s trust department and confirm where the funds belong. That one call can protect both you and your firm.

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4. Misunderstanding Flat Fees and the Client’s Right to Choose

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This is one of the more nuanced areas of trust accounting. In California, if a client pays a flat fee or retainer in advance, the default rule is that it belongs in the IOLTA until it is earned. There is only one exception, and it is found in Rule 1.15(b)(3).

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If you want to treat that flat fee as earned upon receipt and deposit it directly into your operating account, you can, but only if you disclose in writing that:

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1. The client has the right to require that the flat fee be deposited into trust until earned, and

2. The client is entitled to a refund of any unearned portion.

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If the flat fee is more than $1,000, the client must sign that agreement.

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If the client chooses to have the fee held in trust, you must deposit it into the IOLTA first. Once you have earned the fee, meaning the work has been completed or the point in the agreement defining “earned” has been reached, you can then transfer it to operating. The sequence matters: deposit to trust first, then transfer when earned.

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Sometimes the problem is not in the contract itself but in administrative oversight. Funds may simply be deposited into the wrong account. Remember, when you attest to your IOLTA compliance, you are responsible for every action your firm takes related to the trust account.

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Make sure every member of your staff understands the rules and knows how to handle client funds correctly. Written procedures, training materials, and posted reminders go a long way in maintaining compliance. It is not about where you prefer the money to go. It is about honoring the client’s right to choose where it is held.

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5. Assuming an Inactive IOLTA Does Not Need Monitoring

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This one catches firms off guard during audits. An IOLTA account that has been quiet for months feels safe. But quiet does not mean clean. You might still have small interest postings, old client retainers that were already earned, or bank fees hitting the account. More concerning, check fraud can occur even on inactive accounts.

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If that account drifts by even a few dollars, it is technically out of balance, and a bar auditor will find it quickly. If there are funds in your IOLTA that you have already earned, it may mean you did not remove them in a reasonable time. It sounds minor, but it is still a rule.

Every IOLTA, active or dormant, must have a monthly reconciliation and a review of every ledger.

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If you find funds remaining for closed matters, check California’s unclaimed property laws. Those balances may need to be remitted to the State Controller after a certain period. Silence is not safety. Reconcile every trust account, every month, without exception.

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Building Structure That Protects Your Firm

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IOLTA compliance is one of those areas where small habits make the biggest difference. When your reconciliations are timely, your transfers documented, and your client agreements written clearly, you protect more than your books. You protect your credibility. Because when your IOLTA is right, your firm’s foundation is right. 

 

At Chief Bookkeeping Officer, we help law firms build the kind of bookkeeping structure that aligns with bar compliance, CPA standards, and day-to-day operations.

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Peace of mind does not come from crossing your fingers. It comes from reconciling every account.