Law Firm Accounting: What is the IOLTA?

State laws require attorneys to operate with a minimum of two bank accounts. One is the primary bank account through which the firm does business. The other is what is known as the Interest on Lawyer Trust Account (IOLTA). It is this second account that most often leads law firms to seek out CPAs.

Accounting is already a complex matter even for the simplest of businesses. In the legal sector however, things are a bit different. Attorneys are entrusted with funds that do not belong to them, funds that can be dispersed in any number of ways. Accounting for those funds requires a diligent approach and quite a bit of knowledge of both federal and state law.

IOLTAs in the U.S.

The IOLTA was birthed in the 1960s in Australia and Canada as a means of generating money to pay the legal fees of people who could not afford representation. We picked it up in the U.S. in 1981. We use it for much the same purpose: raising money for charitable causes, usually in the form of legal services to the indigent.

Prior to 1981, attorneys used to manage all of their funds in a single checking account. Even funds they were just managing temporarily went into the checking account and were handled on the ledger through separate client entries. It is still possible to do things this way, but there are some decided disadvantages.

For example, any such accounts are not allowed to earn interest. Why? Attorneys are prohibited from deriving earnings from money that does not belong to them, explains Dallas CPA accounting firm Gurian CPA. This presents a problem for attorneys that want to earn interest on their own funds.

By establishing the IOLTA, government regulators provided a separate banking vehicle that allows managed funds to earn interest without attorneys directly benefiting from it. So where does the interest go? It goes to fund those previously mentioned charitable activities. Client funds can be deposited into an IOLTA and then dispersed as necessary. Interest generated by the account is forwarded to the IOLTA program.

Managing IOLTA Accounts

As you might imagine, there is an awful lot of money flowing in and out of a typical law firm. Clients may give funds to an attorney to cover future expenses. By the same token, a client may be due to settlement of some sort. Settlements are generally dispersed through the attorney.

It is easy to imagine how much money flows through a law firm just by imagining how many clients that firm serves every year. No doubt, managing IOLTA accounts can be a nightmare. Fortunately, experienced CPAs knows just what to do. A CPA will create a chart of accounts (COA) just for the IOLTA account alone. Within that chart are numerous sub-accounts assigned to each client who has money flowing through the law firm.

It is in the best interests of the CPA to manage an IOLTA by using the following accounts in the COA:

  • Trust liability
  • Trust interest payable
  • Reimbursable client expenses
  • Referral income.

Now, imagine running a law firm with half-a-dozen partners and the same number of junior partners. All of you are serving dozens of clients every year. Think about what managing your law firm’s IOLTA would be like. You wouldn’t be able to do it yourself and still manage the practice. That would mean either hiring a CPA or contracting with a firm like Gurian.

The IOLTA is a very valuable tool for law firm accounting. It is a tool that both CPAs and practice owners alike have to be familiar with.

Justin Author