Law firms are obligated to keep their clients’ money in a different and special trust account known as “IOLTA” (Interest on Lawyer Trust Accounts).

Trust accounts are bounded by certain rules regarding what they can and cannot be used for. And there are strict penalties for the defiance of these rules; sometimes punishments can be as severe as disbarment.

What is IOLTA?

Before there was such a thing as IOLTA accounts, federal laws dictated that client funds be deposited in a non-interest-bearing account. Then, lawyers were legally prohibited from earning interest from their client’s money.

However, with the introduction of IOLTA, the new rules allowed for law firms to have these funds deposited in an interest-bearing account, but there was a catch.

Subsequently, any interest generated from these IOLTA accounts were automatically forwarded to the state board. These funds (interests) would then be used to cover the legal expenses for underserved and low-income residents.

Does IOLTA exist in my state?

IOLTA programs are available in every state, and usually, banks that operate your regular business accounts would normally manage IOLTA accounts as well.

Furthermore, the guidelines for every IOLTA program is usually similar, but specific rules may vary depending on state. In some states, IOLTA is optional, while in others it is mandatory. Thus, it is pertinent that you get in touch with your State Bar Association and possibly a professional accountant before you set up your IOLTA.

A hypothetical example of how IOLTA works

Let’s assume that your law firm has agreed with Janice, a surgeon, to represent her in a lawsuit. Janice then pays the law firm a retainer fee of $10,000, which your law firm deposits into Janice’s trust account.

Despite the accounting method used by your law firm, it is bounded by the IOLTA guidelines to abide by the double-entry accounting method.

Therefore, law firms are expected and bounded by the IOLTA guideline to keep a separate ledger for individual client account, regardless of the amount. So, Janice’s unique ledger should look like this;

Let's also add that your firm on the same day works for 8 hours on Janice’ case and sets the price of its services at $100/hr. Thus, the firm has the right to withdraw $800 from Janice’s IOLTA account and move it to its business account. However, Janice must be given a chance to review and authorize the withdrawal of this fee via an invoice provided to her with applicable charges.

So, after the withdrawal of $800 for legal service charges, Janice’ ledger should now look like this;

In this particular case, when the law firm works 100 hours on Janice’s case, the entire amount of $10,000 would be considered earned income. Therefore, the Law Firm’s Business Bank account would have a balance of $10,000, the Earned Income account would increase by $10,000, and the Client Trust Liability and the IOLTA Bank Account would be at $0.