Law Firm Trust Accounting: IOLTA Rules, Reconciliation, and Compliance

An IOLTA account is a pooled, interest-bearing bank account where a law firm holds client money that is small in amount or held for a short time. IOLTA stands for interest on lawyer trust accounts. The principal always belongs to the client. The interest goes to the state's IOLTA program, which uses it to fund civil legal aid.

That is the whole idea. Everything else in trust accounting follows from a simpler rule: the money in the account is not yours, and you have to be able to prove whose it is, to the dollar, on any given day.

Why the interest goes to legal aid

Small client balances held briefly cannot earn meaningful interest for the client. Bank fees and the cost of administering the account eat it. Before IOLTA, that money sat in non-interest-bearing accounts and the interest went nowhere.

The Florida Bar Foundation launched the first IOLTA program in 1981, after legislation permitted interest-bearing checking accounts and the IRS settled the tax treatment. The 1981 ruling confirmed that interest on nominal and short-term client funds is not income to the client when it is paid to a bar foundation under a state plan. Other states followed, and every state and the District of Columbia now operates a program. The National Association of IOLTA Programs keeps the history.

When client funds should not go into IOLTA

This is the part firms get wrong in the other direction. IOLTA is for money that cannot practically earn net interest for the client. A large settlement, or funds you will hold for months, belongs in a separate interest-bearing account opened for that client, with the interest going to the client.

There is no universal dollar threshold. The test is whether the amount and the holding period would produce interest for the client after bank charges and administrative cost. Putting a $400,000 settlement in your pooled IOLTA account for four months is a trust accounting error, not a donation.

IOLTA program by state

Programs differ in who has to participate. The ABA identifies three types: mandatory, where every lawyer holding client trust accounts must participate; opt-out, where lawyers participate unless they affirmatively decline; and voluntary, where lawyers have to opt in. Programs were created either by order of the state's highest court or by statute.

If your firm practices in more than one state, this matters operationally. Interest remits to the program in the jurisdiction where the account sits, reporting cadences differ, and a few states require certification on annual registration. The ABA maintains a current status of IOLTA programs by state. Check it against your own footprint rather than assuming one state's rules travel.

The records you have to keep

IOLTA accounting is mostly a recordkeeping obligation, and the required list is more specific than most firms realize.

The ABA Model Rules on Client Trust Account Records set out what a firm should be able to produce. Receipt and disbursement journals identifying the date, source and description of every deposit, and the date, payee and purpose of every disbursement. A separate ledger for each client showing the source of funds, the amounts held, and every charge and withdrawal. Copies of retainer agreements, accountings sent to clients, bills rendered, and records of disbursements made on a client's behalf. Bank statements, deposit records and cancelled checks, physical or electronic. Records of every electronic transfer, including who authorized it and confirmation from the bank. The model rule proposes retaining all of it for five years after the representation ends.

States adopt versions of this rather than the text itself, so check your own rule. But if you cannot produce a per-client ledger with a running balance, you have a problem regardless of jurisdiction.

The three-way reconciliation, and how it fails

Three balances have to agree: the bank statement, the trust account balance in your books, and the total of every individual client ledger. Many states require this monthly. California requires it monthly and assigns each trust account a designated licensee, a named attorney answerable for the account.

The common failure is doing two of the three. A firm reconciles the bank statement to the book balance, finds they match, and stops. That reconciliation will tie perfectly while one client's ledger sits negative and another client's money is quietly covering it. The client ledger total is the leg that catches it, and it is the one most often skipped.

The other failure is timing. Reconciliation has no client attached and no deadline until the bar supplies one, so it slides. Before California launched mandatory compliance reviews, it ran a voluntary pilot. Of the 18 firms that completed it, 15 had noncompliant trust account journals, 16 had noncompliant client ledgers, and 15 had noncompliant monthly three-way reconciliations. These were firms that volunteered.

The malpractice traps

Most of them are administrative rather than dramatic.

Commingling of funds is the obvious one, and it runs both ways. Firm money left in trust to cover bank charges is commingling in most states. So is leaving an earned fee sitting in trust after you have billed it.

Disbursing against an uncleared deposit is the one that does real damage. A settlement check is deposited, funds appear available, the firm wires out the client's share, and the check later fails. For the days in between, that disbursement was funded by other clients' money.

Then the quieter ones. Bank fees taken out of the trust account instead of the operating account. Negative client ledgers hidden by a healthy pooled balance. Old balances nobody has chased, which eventually raise escheatment questions. Records reconstructed after the fact rather than kept contemporaneously.

Worth knowing: in many states the bank reports a trust account overdraft directly to disciplinary counsel, and the report goes out whether or not the check is honored. You do not get to fix it quietly first.

Who owns it inside the firm

At a 40-attorney firm this usually lands on one controller who also owns billing, collections, payroll and the month-end close. That concentration is itself the risk.

Separate the duties where you can. The person who records receipts should not be the only person who reconciles. Signatory authority on the trust account should be narrow and documented. Someone senior should review and sign the monthly reconciliation, with a record that the review happened, because a reconciliation nobody signed is hard to defend later.

What to look for in legal trust accounting management software

General accounting software tracks the pooled bank balance. It does not natively keep a running balance per client matter, which is the record the bar asks for.

Legal accounting software should hold a live per-matter balance, refuse a disbursement that would overdraw one client even when the pooled account covers it, keep trust and operating strictly separate, produce the three-way reconciliation on a schedule rather than on request, and retain a full audit trail for the retention period your state sets. If trust sits in one system and the general ledger in another, the tie-out becomes manual work every month and that is where the delay starts.

The same applies if trust lives inside your legal practice management software. Check that it produces the actual reconciliation report your bar expects, not a summary you have to rebuild in a spreadsheet.

Trust accounting rarely fails because someone stole money. It fails because the reconciliation was late, the client ledger was never kept properly, and nobody noticed until an examiner asked.