The Orange County Bookkeepers Guide: 7 Key Concepts in Client Trust Accounting

Trust Account Bookkeeping
April 1, 2024

The State Bar of California cites seven main concepts for successful trust account management. Upholding these concepts and knowledge of the updates to Rule 1.15 and Rule 2.5’s Client Trust Account Protection Program (CTAPP) is an operational foundation for attorneys seeking to remain in compliance with trust account management responsibilities. 

Let’s dive into the key concepts in client trust accounting and how Orange County bookkeepers at SmartBean® can help you.

1. Separate Clients are Separate Accounts 

A reminder on trust accounts: law firm’s clients and third-party funds may be placed in two types of client trust accounts.

  1. The first is an IOLTA – Interest On Lawyers’ Trust Accounts. A pooled IOLTA account is used when funds are nominal in size and only need holding for a short amount of time.
  2. The next account type is an individual trust account. Individual trust accounts are used upon the client’s request or when their money will be held for a longer period of time, and if it can generate interest that surpasses the charges for setting up the account. 

It is an attorney's obligation to uphold all regulations when managing client trust accounts and meticulously oversee the client’s funds via outlined record-keeping procedures and the trust accounting handbook’s Key Concepts. 

As mentioned, multiple clients' monies are often held together in one trust account, and it is crucial to know what money belongs to whom and to always keep the correct running bank balance. Although the money sits together in the actual account, it is used as though it were in separate bank accounts. Equally, on paper, you must track it separately in client ledgers. Using client ledgers for each separate client creates the simplicity of knowing what funds belong to which client. As outlined in Rule 1.15 (d)(3), using one client's money to pay another client’s obligations is forbidden.

This is a surefire way to lose track of how much money belongs to each client when you begin making payments, even if it is done by mistake. Further, the State Bar considers this a misappropriation of funds. This is why client ledgers are a requirement, even if funds aren’t in an IOLTA. 

2. You Can’t Spend What You Don’t Have 

Following concept number 1, the second key concept in client trust accounting is “You Can’t Spend What You Don’t Have.”

If you are working with a pooled IOLTA for client funds, know that no matter how much money is in the account, you can only use funds from each client’s respective money for their expenses. For example, if you must pay a third party on the client’s behalf, but the client is short on funds, and there is excess within the account, you can’t use the money to solve this issue.

If you do not have enough money for a client's payment, the solution is simple: There is not enough in the account.

It is unethical to dip into another client's funds. However, this will likely happen if you don't keep proper records. Per State Bar regulations, misappropriation of funds occurs when the failure to maintain an appropriate client trust account balance occurs. 

3. There Is No Such Thing As A Negative Balance 

The third concept, “There Is No Such Thing As A Negative Balance,” references a common practice of checkbook holders. Checkbook users sometimes write checks for an amount over or “against” what is currently in the account.

In these cases, the checks are often written with funds pending deposit that would cover the check amount.

However, usually due to processing wait times, they aren’t yet cleared and readily available for use. Those waiting funds are considered a “negative balance.” However, the “negative balance” is not an acceptable or existing concept in client trust accounting. If a trust account has a negative balance, the California State Bar considers this negligence or theft by the attorney. 

There are three existing options for holding client funds, only two of which are permissible. A client trust account may have a:

orange county bookkeeper helping client understand the concepts of client trust accounting

4. Timing Is Everything

Did you know when client funds are deposited via bank deposit forms, they are not deposited right away?

Factors such a financial institutions' respective processing times, out-of-state deposit protocol, and insurance settlement wait times can affect when funds are “available for use” in client trust bank accounts. For this reason, the fourth key concept is “Timing Is Everything.” To prevent the potential headache of the above, it may be beneficial when setting up trust accounts to request the bank’s deposit schedule to learn when funds are available for withdrawal.

This will allow you to avoid bounced checks or using another client’s money. Although it may be inconvenient, until the money has cleared the bank, no payments can be made to or on behalf of your client. 

Some banks do offer preventative services. However, many of these need to meet the stipulations for remaining in compliance with CTAPP. The “Instant credit” is the first of these services. The bank arranges to instantly credit the account with deposits while the bank itself waits for the funds from another financial institution. This arrangement is essentially a loan to the attorney whose name is on the client trust bank account.

Regarding Rule 1.15, since the loan is in the attorney’s name, the funds technically belong to the attorney. If money belonging to the attorney is with money belonging to the clients, this becomes a commingling violation. 

Most banking institutions offer auto draft protection, which means the bank makes a personal loan to the account to keep checks from bouncing.

This may not be the best solution for trust accounts as some instances of overdraft protection cause commingling to occur. The State Bar’s Committee on Professional Responsibility and Conduct (COPRAC) stated that simply using a provided overdraft protection does not immediately mean an attorney is committing an ethical violation. If the deposited amount accounts for the exact amount the bank account will be under, there will be no violation. In this instance, this is the only way that there is no violation. 

5. You Can’t Play The Game Unless You Know The Score 

You can’t play the game unless you know the score. We have reached client trust accounting key concept number 5.

Attorneys and firms must always be mindful of the running balance, which is the amount within the trust account at any given time. The running balance is calculated after adding deposits and subtracting payments; examples of these respective actions are any earned interest or bank charges. 

Running Balances

There is another level to calculating the running balances: there are technically two running balances.

  1. The first one is the amount of money you are holding for each individual client. The running balance for each individual client is kept in the client ledger.
  2. The second running balance is for each client trust bank account. The running balance for the trust bank accounts live separately in the account journal.

While this could seem confusing, think of it this way for the next time you complete trust account reconciliation. Each time a deposit is made on behalf of a client, track the deposit in the client ledger, adding it to the prior balance. Likewise, when making a payment for the client, you track it in the client ledger, subtracting it from the prior balance. This gives the running balance of how much remains for the client to spend.

The same process is repeated in the trust account reconciliation process for the account journal for all of the client trust bank accounts. This will total the running balance of how much money (combined) is available. 

6. The Final Score Is Always Zero 

Success in trust account management is properly holding funds for your clients without misappropriating or commingling funds. Thus, when the attorney-client relationship (or matter resolution occurs), ‘The Final Score Is Always Zero,’ which is Key Concept Number 6. All money should equal zero once all the received funds have been paid out.

There should never be overages or shortages. The truth in client trust accounts is this: no matter how small a remaining balance may be, it is the responsibility of the attorney who was holding it. Some of the most common potential reasons for leftover balances range from mathematical errors to checks that didn’t clear. Either way, it is still the account holder's responsibility to know why it remains.

The longer an inactive balance is in the account, the harder it will likely be to account for where it came from. Therefore, determining the origin of these monies should be done as soon as possible. 

7. Always Maintain An Audit Trail 

An audit trail is hard proof of what you did with the money you handled on behalf of the client. It makes it possible to trace every transaction in the event of questioning–i.e., an audit. It begins when you receive funds on behalf of your client, and it ends when the final payment you’ve made on their behalf clears.

The audit trail is created using both bank-created records and attorney-created records.

How to Have a Good Audit Trail

A proper audit trail should have the following: 

Leaving an audit trail can also be an asset when mistakes occur– which is common when working with money. Records should be as descriptive as possible. When filling out deposit slips, include the client’s name, bank identification code, and check amounts for each check.

To take it a step further, keep duplicates for your records, and always specifically clarify which client withdrawals and deposits are for. Avoid checking out ‘CASH’ as well. It becomes nearly impossible to track after time has passed, but you are still legally obliged to have an answer.

Master Client Trust Accounting in Orange County with SmartBean®!

If your team needs assistance with legal trust accounting, look no further than the SmartBean® TAB–Trust Account Bookkeeping services in Orange County, California. Our dedicated team of bookkeepers is uniquely experienced with California’s expanded trust account bookkeeping rules and will assist your firm in reaching and maintaining compliance.

Receive a free consultation from our team of bookkeepers today!

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