The rules for trust accounting come down to one idea applied through many specific requirements: money you hold for someone else is theirs, not yours, and every dollar has to be traceable back to the person it belongs to. In practice, that means keeping trust funds in a dedicated account at a bank that reports overdrafts, recording every transaction across three linked ledgers that reconcile each month, disbursing only for the client whose funds are being drawn, and meeting separate reporting obligations to both beneficiaries and the IRS. The rules apply to attorneys holding settlement proceeds, executors administering estates, title companies handling escrow, and any other fiduciary in custody of third-party money.
Keep Trust Funds Separate From Your Own
Segregation is the foundational rule. The American Bar Association’s Model Rule 1.15, which most states use as the template for attorney trust account rules, requires a lawyer to hold client property “separate from the lawyer’s own property” in a dedicated account.1American Bar Association. Rule 1.15: Safekeeping Property The same principle governs executors, trustees, and escrow agents.
Commingling — mixing trust money with personal or business funds — is a violation regardless of intent. It does not matter that you meant to return the money the next day, or that no client actually lost anything. The act itself is the breach, and regulators treat it as a presumption of misappropriation. The only fiduciary money allowed in a trust account is a small deposit to cover the bank’s service charges on the account.1American Bar Association. Rule 1.15: Safekeeping Property Using the trust account to float operating expenses, cover a temporary shortfall, or park personal savings is prohibited.
Alongside segregation sits the duty of loyalty. The Uniform Trust Code states it directly: a trustee must administer the trust solely in the interests of the beneficiaries.2Uniform Law Commission. Uniform Trust Code Section-by-Section Summary A transaction where the fiduciary has a personal stake is presumed harmful and can be voided, and the beneficiary does not have to prove actual loss.
Setting Up the Account
The account has to be held at a financial institution and titled to show its fiduciary nature. Common designations include “Trust Account,” “Client Funds Account,” or “Escrow Account.” The bank’s willingness to comply with regulatory reporting obligations matters as much as the account name. Under the ABA’s model rules for overdraft notification, the bank must report every instance where a check is presented against a trust account with insufficient funds, whether or not the bank honors the check.3American Bar Association. Model Rules for Trust Account Overdraft Notification A bank that will not make those reports is not an acceptable choice.
IOLTA or Separate Client Account
Small amounts or funds held briefly go into a pooled Interest on Lawyers’ Trust Account (IOLTA). Multiple clients’ funds share one interest-bearing account, and the interest is forwarded to a state bar foundation for legal aid rather than to individual clients. The rationale is that any single client’s share of the interest would be too small to justify the administrative cost of a separate account.
Substantial funds, or funds you expect to hold for a long time, belong in a separate interest-bearing account opened for that specific client or matter. Interest earned in these accounts belongs to the beneficiary. There is no universal dollar threshold that divides “nominal” from “substantial”; the judgment depends on the expected interest, the cost to administer a standalone account, and the holding period.
FDIC Pass-Through Coverage
Deposit insurance for trust accounts works on a pass-through basis. Each beneficiary’s interest is insured up to $250,000, provided the fiduciary relationship is disclosed in the bank’s account records.4eCFR. 12 CFR 330.5 – Recognition of Deposit Ownership and Fiduciary Relationships In an IOLTA, each client counts as a separate depositor for coverage purposes. For formal trusts, an owner’s deposits are insured up to $250,000 per eligible beneficiary, capped at $1,250,000 when five or more beneficiaries are named.5FDIC. Trust Accounts If the bank’s records don’t identify the underlying beneficiaries, the FDIC will not extend pass-through coverage. When a national bank places fiduciary funds in its own institution, federal regulations require it to set aside collateral equal to the uninsured portion.6eCFR. 12 CFR 9.10 – Fiduciary Funds Awaiting Investment or Distribution
The Three-Ledger System
Trust accounting runs on three coordinated records, each with a different job. Every transaction must be entered immediately; delayed entries create the ambiguity that leads to one client’s funds accidentally covering another’s.
- The trust account general ledger records every deposit and disbursement across all clients in chronological order and shows the total account balance at any moment.
- Each client or matter gets an individual client ledger tracking that client’s funds specifically. Its balance reflects what you owe that client, and it must never go negative.
- The trust account check register captures the details of every payment: check number, date, payee, amount, and the specific matter the payment relates to.
The Monthly Three-Way Reconciliation
Each month, three figures must match exactly: the adjusted bank statement balance (after outstanding checks and deposits in transit), the general ledger balance, and the sum of all individual client ledger balances. Any discrepancy means either a bookkeeping error or misallocated funds.
Review each client ledger during reconciliation for negative balances. A negative balance on one client’s ledger means another client’s money paid that client’s obligations. That is commingling even when the overall trust account balance is positive.
How Long to Keep the Records
Retention periods depend on the fiduciary and the jurisdiction. The ABA’s model rules recommend keeping trust account records for at least five years after the representation ends.7American Bar Association. ABA Model Rules on Client Trust Account Records – Rule 1 Recordkeeping Generally National banks acting as fiduciaries must keep records for at least three years after the account terminates or any related litigation concludes, whichever is later.8eCFR. 12 CFR 9.8 – Recordkeeping State rules commonly set five to seven years. Keep records at least as long as your jurisdiction requires, and longer when in doubt.
Deposits and Disbursements
Funds received on behalf of a client — settlement checks, earnest money, estate proceeds — must be deposited promptly. Most jurisdictions read “promptly” as one to three business days. Holding a check for a week because other matters took priority is a violation even when nothing goes wrong.
Wait for Funds to Clear
Before disbursing against a deposit, confirm the funds have actually cleared. A check is not real money in the account until the issuing bank honors it. Hold periods vary by instrument, amount, and the banks involved. Disbursing early is one of the most common ways fiduciaries stumble into commingling without meaning to: if the deposit bounces, the trust account is short, and every subsequent disbursement is being paid with another client’s money.
What Counts as a Permissible Disbursement
Every withdrawal must benefit the specific client or matter whose funds are being drawn. Paying a third-party vendor on a client’s behalf, forwarding settlement proceeds, and transferring earned fees to the operating account are all allowed if authorized and documented. Using one client’s funds to cover another’s disbursement, paying office rent from the trust account, or lending trust funds to yourself is prohibited without exception.
Moving Earned Fees Out
The most frequent legitimate transfer is withdrawing earned fees. A fee becomes earned only when the work has been performed or the triggering condition met. Before that point, an advance retainer is still the client’s money and stays in the trust account. Once the fee is earned, transfer it promptly, because letting earned fees sit in the trust account is itself commingling: your money is now mixed with client funds. If any portion of a fee is disputed, the disputed amount stays in trust until the dispute is resolved.
Reporting to Beneficiaries
Fiduciaries have an ongoing obligation to keep beneficiaries reasonably informed. The Uniform Trust Code requires, at minimum, annual accountings to qualified beneficiaries.2Uniform Law Commission. Uniform Trust Code Section-by-Section Summary For attorneys and other professionals, reporting frequency is typically fixed by the engagement agreement or the governing trust document. At the end of a matter, a final accounting must detail every receipt, disbursement, and transfer, and confirm the net balance owed to the beneficiary.
Tax Filings for the Trust or Estate
A trust or estate that generates income has its own tax obligations, separate from what beneficiaries report on their personal returns. A fiduciary must file IRS Form 1041 for any domestic estate with gross income of $600 or more during the tax year, or for any domestic trust with any taxable income or gross income of at least $600.9Office of the Law Revision Counsel. 26 USC 6012 – Persons Required to Make Returns of Income Filing is also required if any beneficiary is a nonresident alien, regardless of the income amount.10Internal Revenue Service. Instructions for Form 1041
Along with Form 1041, the fiduciary issues a Schedule K-1 to each beneficiary who received a distribution or an allocation of income, reporting their share of the trust’s or estate’s income, deductions, and credits for use on their personal return.11Internal Revenue Service. About Form 1041, U.S. Income Tax Return for Estates and Trusts The penalty for failing to provide a K-1 on time, or providing one with wrong information, is $340 per form, capped at $4,098,500 per calendar year.10Internal Revenue Service. Instructions for Form 1041 If the failure is intentional, the penalty doubles and the cap disappears.
Unclaimed Funds
When a fiduciary relationship ends and the beneficiary cannot be located, state unclaimed property laws eventually require the funds to be turned over to the state. Every state has an escheatment statute that sets a dormancy period — the time funds must sit unclaimed before the state takes custody. Dormancy periods vary by state and by property type, generally ranging from one to fifteen years. Before reporting funds as unclaimed, the fiduciary must complete legally required due diligence to locate the owner. Missing the escheatment requirements can trigger state penalties and interest.
How Violations Get Detected and What They Cost
The most powerful enforcement trigger is automatic overdraft reporting. When a bank reports a trust account overdraft, the disciplinary body does not decide whether to investigate; the notice arrives, and an investigation opens. For attorneys, accepting overdraft protection or a line of credit on a trust account is itself an ethical violation, because it hides the shortfalls the reporting system is meant to catch.3American Bar Association. Model Rules for Trust Account Overdraft Notification Many jurisdictions also run random compliance audits, comparing the fiduciary’s records against the bank’s and looking for negative client ledger balances, missing or backdated reconciliations, and undocumented transfers between the trust and operating accounts.
Misappropriating client funds — through outright theft or through negligent record-keeping that lets money disappear — draws the most severe available sanction. For attorneys, that typically means disbarment. Courts have held that converting client funds for personal use is an act of moral turpitude that, absent extraordinary mitigating circumstances, calls for permanent removal from the profession. The aggrieved client can also sue for the full loss plus interest and potentially punitive damages, and depending on the facts, criminal charges for theft, fraud, or embezzlement can follow. None of this is limited to intentional theft. When there is an unexplained shortfall, the fiduciary bears the burden of proving every dollar is accounted for.
Protecting the Account From Wire Fraud
Business email compromise is now one of the leading threats to trust and escrow accounts. A criminal gains access to an attorney’s or client’s email and sends fraudulent wire instructions that reroute funds. The same tactic targets real estate closings by impersonating title companies or agents.12Financial Crimes Enforcement Network. Advisory to Financial Institutions on E-Mail Compromise Fraud
Verify every wire instruction through a channel other than email before executing the transfer. Call the client at a number you already have on file, not one supplied in the suspicious message. Multi-factor authentication on any account that can move money is no longer optional for a fiduciary. If unauthorized funds do leave the account, report it to law enforcement within 24 hours; recovery rates fall sharply after that window closes.12Financial Crimes Enforcement Network. Advisory to Financial Institutions on E-Mail Compromise Fraud