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Trust accounting is a complex, niche field that spans the financial and legal industries. Dedicated software can make trust accounting easier to handle, but successful implementation requires an understanding of specifically how that software can help lawyers, accountants and other parties manage trust funds and the assets that those funds produce.
This buyer’s guide will not only serve as a primer on what trust accounting is, but also explain what specific things software buyers should look out for if they’re in the market for a trust accounting system.
In its largest sense, the term "trust accounting" refers to the financial management of trust accounts—accounts in which a trustee holds funds for some specific purpose.
When talking about general trust accounting, though, we are more specifically referring to accounts created as a part of estate planning (the dispersal and management of a person's assets after their death).
Adding to the confusion is the fact that this form of trust accounting, or "fiduciary accounting," has a counterpoint in the legal profession. Although legal firms are frequently involved in trust accounting for estate planning and other purposes, "legal trust accounting" refers to a different, separate practice.
What Is Legal Trust Accounting?
Lawyers create legal trust accounts for a few reasons, including:
They have been given advance fees (such as retainers) by clients
They are holding funds for clients in connection with payment of a settlement
They are holding client funds as a fiduciary for that client
By law, these accounts must be separate from the lawyer's own personal or business account, making legal trust accounting an essential part of legal practice and ethics.
In many cases, these trusts are eligible for the IOLTA (Interest on Lawyers Trust Accounts) program, which takes the interest from lawyers' trust accounts and uses it to provide legal aid on civil matters to low-income families and individuals. All 50 states currently have an IOLTA program.
According to the program's website, "A lawyer who receives funds that belong to a client must place those funds in a trust account separate from the lawyer's own money. Client funds are deposited in an IOLTA account when the funds cannot otherwise earn enough income for the client to be more than the cost of securing that income. The client—and not the IOLTA program—receives the interest if the funds are large enough or will be held for a long enough period of time to generate net interest that is sufficient to allocate directly to the client."
One of the main features of legal trust accounting software is automated management and accounting of those IOLTA funds, making lawyers the primary customers of trust accounting software vendors.
The products we'll be discussing in this guide are specifically geared toward legal trust accounting, though we will be referring to it as "trust accounting" for simplicity's sake.
Common Features of Trust Accounting Software
Different trust accounting systems will have different features, depending in part on how integrated they are with a more robust suite of legal and/or accounting software. The most typical features are explained in the following chart.
Create financial statements tracking funds across multiple trust accounts. Lawyers must be able to produce a report showing how funds in a trust account are used. This also allows you to reconcile trust accounts every month and be audit-ready should the need arise.
Almost all trust accounting software integrates with (or comes in a suite with) more generalized legal billing/timekeeping software that allows for easy creation of invoices and payment collection, while squaring those exchanges with trust accounts.
Track the ledgers of multiple accounts for multiple clients, avoiding the mistake of commingling accounts. Organize by legal matter or client to customize according to your preference.
For accounts that qualify, track the interest accrued, make automatic payments into the program and make sure you are abiding by the IOLTA rules of your state.
Trust account automation
Some systems will apply trust monies directly through automatic billing, keeping the accounts balanced without the need for manual transactions.
Many states have laws that regulate how attorneys can maintain lawyers' trust accounts. Software can help you make sure you follow all relevant local and national legislation.
Some trust accounting systems provide free account access for an external financial advisor, so that you can have your chosen expert double-check your compliance.
What Type of Buyer Are You?
Although lawyers and law firms are the primary buyers of this type of software, they are not the only parties interested in legal trust accounting. Other buyers might include: bank trust departments, independent trust companies, accountants/CPAs, family offices, guardians, foundations and nonprofit organizations.
However, most buyers will be lawyers and law firms, falling into one of the following three categories:
Solo law practice. These are practices with only one attorney, who may or may not also have an outside bookkeeper. More frequently, however, these attorneys will keep their own records, and thus, trust accounting software will be crucial to monitor any trust accounts and abide by all state and federal regulations. These buyers will most likely have a need for other legal software functions, with trust accounting as part of a larger system.
Small or midsize law firm. These are practices with multiple lawyers, and most likely have an on-staff or outsourced accountant. Legal billing software will be of crucial importance for that accountant (or to the individual attorneys if there is no bookkeeper), and trust accounting software should be considered a vital component of that software suite.
Large law firm. These are firms with many partners and associates, and a full accounting team. They will require a robust software system that includes billing, case management and legal document management. Trust accounting software, as one component of that system, will be extremely important, to make sure that the multiple trust accounts of various attorneys in the firm are maintained ethically, legally and accurately.
Benefits and Potential Issues of Trust Accounting Software
A trust accounting software system allows for easier, more automated management of attorneys' trust accounts. Though just a small part of running a law practice, trust accounts are nevertheless extremely important, and need to be properly handled. Trust accounting software can make this easier. Some benefits of using this software include:
Ethical and legal compliance. Trust accounting software can help you make sure you follow all the rules of ethics and law surrounding trust accounts in your state. This will increase your accountability to your clients, to yourself and to the state bar.
Separation of accounts. Software will let you keep track of multiple accounts so you don't run the risk of accidentally commingling client funds with your own accounts.
Increase client/audit readiness. If your client asks for reports about their account, or if you should be audited, trust accounting software ensures that you have proper, thorough records of all transactions, including deposits, payments, interest etc.
An example of CosmoLex trust accounting preventing an error
However, an overreliance on software is always a danger. In the case of the legal profession, making a mistake with your software will not save you from potential ethics violations or legal repercussions. Be sure you aren't just blindly following the software, and that you are well-informed about local and federal regulations regarding legal trust accounting. The software will aid you in managing those trusts, but it does not replace your own required due diligence.
Market Trends to Understand
Here are some market trends you should consider as you select a product:
Cloud-Based Software.Cloud-based systems are increasingly popular. They require less hardware than on-premises software as well as less IT knowledge, have lower upfront costs, and are more quickly implemented, making them a good choice for smaller firms/businesses, in particular.
Mobile functionality. As with most software at the moment, trust accounting systems are beginning to add mobile functionality, allowing you to access your software from a phone or tablet. This is particularly beneficial to solo firms where you can't be constantly bound to the office.