What Is an IOLTA Account, and Why Do Law Firms Get It Wrong So Often?

Most law firms know they need an IOLTA account. Far fewer understand how to account for it correctly. The result? Financial reports that look profitable but mask serious problems, partner distributions based on phantom revenue, and trust accounting errors that turn routine bar audits into existential threats. IOLTA isn’t just a compliance requirement, it’s a financial control system that most firms treat like a checking account.

What an IOLTA Account Really Is?

An IOLTA (Interest on Lawyers’ Trust Account) is a dedicated bank account where attorneys hold client funds that don’t belong to the law firm. The money inside isn’t firm revenue. It’s not operating cash. It’s a liability, funds held in trust that must be returned to clients or paid out on their behalf.

The interest generated by pooled IOLTA accounts goes to state bar foundations to fund legal aid programs, not to your firm. This isn’t a technicality. It’s the entire point: client funds remain separate, untouched, and tracked at all times.

IOLTA exists because client money and firm money must never mix. When a client pays a retainer, that money doesn’t become yours the moment it hits your account. It becomes yours only as you earn it through completed work. Until then, it sits in trust, physically and legally separate from your operating funds.

This isn’t a holding account. It’s a fiduciary account. The moment you treat it like anything else, you’re committing an accounting error and potentially an ethics violation.

What IOLTA is not?

This is where most mistakes begin. IOLTA is not:

Firm revenue.	Depositing a retainer doesn’t mean you’ve earned it. Revenue is recognized when services are performed, not when cash is received.
Operating cash.	You can’t pay payroll, rent, or software subscriptions from IOLTA. Ever. Those expenses come from your operating account.
A temporary parking account	IOLTA isn’t a place to stash questionable funds until you figure out what to do with them. Every dollar in that account must be tied to a specific client and a specific obligation.
A holding account to smooth cash flow	Some firms leave earned fees in IOLTA longer than necessary to avoid “running out of money” in their operating account. This is commingling by another name.

If you’ve ever thought “I’ll just leave it in IOLTA for now,” you’re using it wrong.

What Funds Belong in an IOLTA Account?

IOLTA accounts hold specific types of client funds:

Client retainers not yet earned. If a client pays you $10,000 upfront, that money stays in IOLTA until you bill against it and transfer earned fees to your operating account.

Settlement funds awaiting distribution. A $50,000 settlement check belongs in IOLTA until you’ve paid the client, covered liens, and transferred your contingency fee.

Filing fees or court costs held in trust. If you’re holding $500 for a filing fee you haven’t yet paid, it stays in IOLTA.

Advance payments tied to future work. Funds received before work begins or before expenses are incurred belong in trust, not revenue.

The rule is simple: if the money isn’t fully earned or doesn’t fully belong to you yet, it goes in IOLTA.

The 5 Most Common IOLTA Failures and Why They Happen

1. Recording retainers as income immediately: Firms see cash in the door and book it as revenue. Why? Because cash-based thinking dominates small firm accounting. The bookkeeper sees a deposit and records income. The problem: you haven’t earned it yet.
2. Failing to reconcile IOLTA monthly: Many firms reconcile their operating account religiously but treat IOLTA like a black box. Why? Because no one understands it’s a liability account that must balance to the penny against client sub-ledg
3. Commingling operating expenses with trust funds: Firms pay bar dues, QuickBooks subscriptions, or accidental transfers from IOLTA. Why? Poor chart of accounts setup and lack of separation protocols.
4. No client-level balance tracking: The bank says you have $47,000 in IOLTA. But how much belongs to Client A? Client B? If you can’t answer instantly, you’re not tracking trust correctly. Why does this happen? No sub-ledger system or reliance on practice management software that doesn’t integrate with accounting.
5. Missing three-way reconciliation: Proper IOLTA accounting requires three numbers to match: the bank balance, the general ledger liability balance, and the total of all client sub-ledger balances. Most firms check one or two. Almost none check all three monthly.

How Incorrect IOLTA Accounting Distorts Financial Reports?

When IOLTA is handled wrong, every financial report in your firm becomes unreliable.

Artificially inflated revenue.

If you’re booking retainers as income on receipt, your P&L shows revenue you haven’t earned. You look profitable when you’re not.

Misleading profit margins.

Phantom revenue drives up margins. Partners make decisions—hiring, expansion, distributions, based on profitability that doesn’t exist.

Inaccurate partner distributions.

If your comp model uses net income as a factor, and net income includes unearned retainers, you’re distributing money the firm hasn’t actually made.

Cash flow that looks healthy but isn’t.

Your operating account looks flush because you’ve been pulling from IOLTA incorrectly or leaving earned fees there too long. When the reconciliation catches up, the cash disappears.

Tax exposure from phantom income.

If your tax return reflects revenue you didn’t earn, you’re paying taxes on money that isn’t yours. When you later reverse the error, you’re amending returns and explaining discrepancies.

IOLTA errors don’t just violate bar rules. They corrupt the financial data you use to run your business.

The Real Risks of Getting IOLTA Wrong

Bar audits and disciplinary action. State bars conduct random trust account audits. If your records don’t reconcile or show commingling, you face sanctions, suspension, or disbarment.

Client disputes and trust violations. A client asks for their retainer back, and you can’t immediately show their balance. That’s a trust violation and a malpractice risk.

Partner conflict and internal distrust. When IOLTA errors surface, partners question the numbers, the distributions, and each other. Trust breaks down fast.

Difficulty selling or merging the firm. Buyers conduct financial due diligence. If your IOLTA accounting is a mess, clean books don’t exist. The deal dies or the valuation craters.

Reputational damage. Word spreads fast in legal markets. A public trust accounting violation damages client relationships, referral networks, and recruiting.

The risk isn’t theoretical. It’s career-ending and firm-ending.

What Proper IOLTA Accounting Should Look Like?

Done correctly, IOLTA accounting is structured, controlled, and transparent:

• Trust funds are recorded as liabilities, not income. Every dollar in IOLTA appears on your balance sheet as a liability, money you owe clients or third parties.

• Client-by-client trust ledger tracking. You maintain a sub-ledger showing each client’s trust balance. The sum of all client balances must equal your IOLTA liability account.

• Monthly three-way reconciliation. You reconcile the bank statement, the general ledger IOLTA liability account, and the client sub-ledger total. All three must match.

• Clear separation from operating accounts. IOLTA and operating accounts are never commingled. Transfers between them follow documented protocols tied to earned fee invoices or expense reimbursements.

• Clean audit trail. Every deposit, withdrawal, and transfer has a corresponding client invoice, court filing, or settlement distribution document.

This isn’t optional. It’s the standard.

Why Generic Bookkeeping Often Fails Law Firms?

Most bookkeepers understand accounts receivable, payroll, and expense tracking. Few understand trust accounting.

1. General bookkeepers don’t understand trust accounting. They’ve never reconciled an IOLTA account, never maintained client sub-ledgers, and don’t know the three-way reconciliation exists.
2. Software alone doesn’t solve IOLTA complexity. Practice management systems track time and trust deposits. Accounting systems track liabilities. Almost none do both seamlessly. The integration gaps create reconciliation failures.
3. Legal compliance ≠ financial accuracy. A firm can pass a bar audit (barely) and still have financial reports that are dangerously wrong. Compliance is the floor, not the ceiling.
4. CFO oversight is missing. Most small and mid-sized firms have a bookkeeper but no financial controller or CFO. No one is validating the structure, testing the reconciliation process, or ensuring IOLTA is treated as a financial control, not just a regulatory box to check.

Generic bookkeeping isn’t wrong. It’s just insufficient for law firms.

IOLTA Accounting Is a Financial Control Problem, Not Just a Compliance Problem

IOLTA errors aren’t ethics violations that happen to affect your books. They’re financial system failures that happen to violate ethics rules.

Getting IOLTA right means your revenue is real, your cash flow is understood, and your partners trust the numbers. It means you can sell the firm, survive an audit, and make decisions based on actual profitability.

Firms that treat IOLTA as a compliance nuisance stay small, stay stressed, and stay vulnerable. Firms that treat it as a core financial control grow with clarity.