The Confusing Case of Retainers and Trust Accounts

Client-Trust-Accounts

One of the most common questions we get at JurisBookkeeping is whether attorneys MUST place advanced fees (often incorrectly referred to as “retainers”) into their client trust account. The argument against doing so seems to be that managing the trust account is an accounting headache. Add to that the possibility of triggering a state bar audit by making a mistake in the trust account, and some attorneys want to find a way to avoid dealing with the trust account altogether.

While we at JurisBookkeeping can appreciate the concerns about additional work and a healthy fear of a trust account audit, we always counsel our clients to use their trust accounts, for these four compelling reasons.

  1. The California State Bar strongly recommends advanced fees be placed in the trust account. While this varies from state to state, the Handbook on Client Trust Accounting for California Attorneys (referencing the deposit of advanced fees into the trust account) states, “while you aren’t clearly required to, the simplest and safest thing to do is to hold advance fees in your client trust bank account and draw them as you earn them.” This is a strong recommendation.
  2. Funds held in trust are afforded special protections. Funds held in the firm’s operating account are deemed to be property of the firm. Accordingly, they are subject to creditors and judgments. Monies held in the trust account are a different story. Because these funds are deemed “other people’s money” – that is, funds being held in trust for the benefit of someone else – they don’t belong to the firm. Accordingly, any liens or judgments against the law firm would never be pulled from the trust account.
  3. Money in trust is never treated as income. From an income tax perspective, you’re much better off holding all unearned fees in your trust account. There can be no argument from the IRS or your tax accountant that fees were earned if they are still in trust. But checks from clients that have been deposited into your operating account might look like income to the IRS, even if there isn’t an invoice associated with the deposit, and even if you can “prove” the fees were not earned.
  4. Advanced fees are almost always entangled with advanced costs, and advanced costs MUST be placed in the IOLTA account. Keeping in mind that advanced costs are REQUIRED to go into the trust account (California RPC 4-100), it’s easy to see why you might as well deposit the advanced fees in the trust account. Most retainers or advanced fee deposits are really intended to cover both advanced legal fees AND advanced client costs. Indeed, I have yet to see an attorney issue two separate client bills – one for advanced costs and one for advanced fees – and only pull the payment for costs from the trust account. Rather, attorneys’ bills almost always bundle legal fees and advanced client costs into one bill. (The exception, of course, are flat fee invoices.) If you send a client a bill that has both legal fees and costs on it and you show the bill as being paid with client funds deposited into your operating account, you’re in violation of the rule that advanced client costs must be deposited into the trust account.

In short, depositing your advanced fees, or “retainers,” into your IOLTA account may cause you a minute or two of extra work, but it will save you hours of headache, if you run into issues with the Bar, and a bit of money at the end of the year when your CPA is doing your taxes.

Have additional questions regarding your advanced fees? Please contact Annette Fadness at JurisBookkeeping.