Key Takeaways
- Law firms hold a lot of money that isn’t theirs, from client retainers to settlement checks. This article covers the five accounting challenges that come with it. Most of the fixes start with keeping client funds separate from your firm’s revenue.
- An IOLTA (Interest on Lawyers’ Trust Accounts) account pools many clients’ money in one bank balance. Your books still have to track each client’s share separately. A monthly three-way reconciliation catches mistakes while they’re small, and Georgia lawyers have to keep those records for six years after a case ends.
- Case costs your firm pays up front on contingency cases generally count as loans to your client. That usually means you can’t deduct them until it’s clear you won’t get them back.
- Settlement checks can create a 1099 mismatch. The insurer usually reports the full settlement on your firm’s Form 1099-MISC, even when most of it goes to your client. In our example, a $90,000 settlement includes a $30,000 fee, and your trust records show the other $60,000 was never yours. As of October 2026, settlement payments to attorneys are reported at $600 or more, and attorney fees at $2,000 or more.
- Unpaid invoices often pile up when billing waits until a case closes. Revenue per attorney won’t flag it, since it counts billed work whether or not the client pays. Clear billing terms and a collection rate for each attorney show which work actually turns into cash.
At Fusion CPA, our certified public accountants (CPAs) clean up a lot of law firm books. Most of them share one root problem. Their accounting system treats every dollar that hits the bank as the firm’s own money. That assumption works for most businesses, but law firms hold client money almost all the time.
Client retainers and settlement proceeds both pass through your law firm’s accounts on their way to someone else. Each one carries its own ethics rule and its own tax treatment. Five challenges trace back to that root problem: trust and IOLTA tracking, case costs, 1099 reporting, receivables, and attorney profitability. For each, we cover what the rules say as of October 2026 and how it affects your books and taxes.
1. How Should Your Firm Track Trust and IOLTA Accounts?
When a client pays a retainer or a settlement arrives, that money isn’t yours yet. American Bar Association (ABA) Model Rule 1.15, which most states have adopted in some form, requires a lawyer to hold client property separately from the lawyer’s own. Fees and expenses paid in advance go into a client trust account. They come out only as the fees are earned or the expenses are incurred.
Many firms hold these funds in an IOLTA account, short for Interest on Lawyers’ Trust Accounts. It’s a pooled trust account whose interest goes to a state program that funds legal aid, often run by a bar foundation, rather than to the firm or the client. At the bank, the setup is simple. Your books are harder, because one bank balance has to break down into a separate running balance for every client.
That breakdown is why many firms run a three-way reconciliation every month. It compares three records that should always agree: the trust bank statement, the trust account register, and the total of all individual client ledgers. When the numbers don’t match, the gap usually traces back to a deposit posted to the wrong client or an earned fee left sitting in trust.
Both errors are common. They’re also much easier to fix in the month they happen than at year-end. If your firm adopts one habit from this article, we’d make it this one. Our guide to trust accounting and IOLTA compliance walks through the reconciliation step by step.
Where Accounting Software Fits
Software handles much of this load once it’s set up for trust work. A general ledger such as QuickBooks Online or NetSuite can record trust activity, but neither tracks client-level trust balances out of the box. Many firms keep client ledgers in legal practice management software and sync summary entries back to the ledger. Whichever setup you use, the test is the same: can you produce each client’s trust balance for any date someone asks about?
How Georgia Handles Trust Accounts
Georgia’s version of the safekeeping rule sits in Rules 1.15(I) through 1.15(III) of the Georgia Rules of Professional Conduct. Georgia lawyers hold trust funds at a bank the State Bar of Georgia has approved, and it publishes its list of approved financial institutions. Approved banks agree to report trust account overdrafts to the Bar, so a single bounced trust check can trigger an inquiry on its own.
Interest on Georgia IOLTA accounts goes to the Georgia Bar Foundation. Rule 1.15(I) also requires complete trust records to be kept for six years after a representation ends. That’s one year longer than the five years the ABA model rule suggests.
For Georgia firms, our Atlanta accounting team builds the trust reconciliation into the monthly close. That way, six years of records already exist when the Bar or a client asks for them. (Rules cited as of October 2026.)
2. Why Do Case Costs Get Misallocated?
Every case carries costs that someone has to track: filing fees, deposition transcripts, expert witnesses, medical records. On hourly matters, firms typically bill those costs to the client as they go. On contingency matters, your firm often pays them up front and recovers them only if the case resolves in the client’s favor.
That timing creates a tax issue many firms miss. Under long-standing case law, including Canelo v. Commissioner, costs advanced on a contingency case with an expectation of repayment are generally treated as loans to the client. They aren’t deductible business expenses when paid.
In most situations, the firm deducts an advanced cost, generally as a bad debt, only once it becomes clear the money won’t come back. A lost or abandoned case is the usual example. Courts have reached different results under some gross-fee arrangements, so the wording of your fee agreement matters here.
Firms that expense advanced costs as they pay them can overstate their deductions while cases stay open. The accounting fix is a dedicated balance sheet account for these costs, tracked by matter. When a case settles, the recovered costs clear that account instead of showing up as new revenue. When a case is lost, the unrecovered costs are generally written off as a bad debt in that year.
Retainers add a second layer. Because an advance fee stays in trust until you earn it, a matter that runs past its estimate will eventually burn through the deposit. From that point, the unbilled work becomes a receivable, which carries its own collection risk.
3. Which 1099 Forms Does a Law Firm Receive or Send?
The Form 1099 series covers information returns, which the Internal Revenue Service (IRS) uses to match payments against tax returns. These forms reach a law firm from both directions. Businesses that pay your firm report those payments to the IRS, and your firm reports certain payments it makes to others. When the forms and your return don’t line up, the mismatch can prompt an IRS notice proposing additional tax.
One rule catches many firm owners off guard. Most payments to corporations are exempt from 1099 reporting, but that exemption doesn’t apply to legal services. A law firm organized as a corporation still receives 1099s.
Form 1099-NEC is only one of the several types of 1099 forms the IRS uses, and law firms commonly deal with two of them. The One Big Beautiful Bill Act raised several reporting thresholds starting with payments made in 2026. The table below shows how the IRS Instructions for Forms 1099-MISC and 1099-NEC (Rev. December 2026) apply to the payments a law firm sees most often.
| Payment | Form and box | Reporting threshold (2026 payments) | Who generally files |
|---|---|---|---|
| Fees a business pays your firm for legal services | Form 1099-NEC, box 1a | $2,000 | The business paying the fees |
| Settlement or other gross proceeds paid to your firm | Form 1099-MISC, box 10 | $600 | The payer, such as an insurance company |
| Fees your firm pays to expert witnesses or referring attorneys | Form 1099-NEC, box 1a | $2,000 | Your firm |
| Profit distributions to partners in a law partnership | Schedule K-1 (Form 1065), not a 1099 | Not applicable | Your firm |
These figures are current as of October 2026, and the $2,000 threshold may be adjusted for inflation starting in 2027. A payment below the threshold is still income to whoever receives it. Only the reporting requirement changes.
If your firm issues 1099-NECs to experts or referring attorneys, the IRS copy and the recipient copy are generally both due January 31. Fees paid to another law firm are reportable even when it’s incorporated. An expert witness firm organized as a corporation, on the other hand, is generally exempt. Firms filing 10 or more information returns in total generally have to file them electronically.
Worked Example: The Settlement Check
Suppose an insurance company pays a $90,000 settlement into your firm’s IOLTA account. Your fee agreement gives the firm one-third, so $30,000 is your fee and $60,000 goes to your client.
Because the $90,000 counts as gross proceeds paid to an attorney, the insurer generally reports the full amount on Form 1099-MISC, box 10. Your firm is listed as the recipient. According to the IRS instructions, the insurer has no separate reporting requirement for the attorney’s fee paid out of those funds. The only 1099 your firm receives from this case, then, shows $90,000.
Your firm’s return, however, should generally include only the $30,000 fee as income, since the other $60,000 passed through trust to your client. This is where the trust ledger matters for taxes. It’s the record that shows how $90,000 of reported proceeds became a $30,000 fee. If your books recorded the full deposit as revenue, the firm would overstate its income by $60,000. If the return simply showed $30,000 with no supporting records, the IRS matching system would still see $90,000 reported against it.
What This Looks Like in Practice
A pattern Fusion CPA’s controller team sees often: a small contingency-fee practice runs its IOLTA deposits through the same bank feed as its operating account. Settlement deposits land in revenue. Client disbursements land in a catch-all expense account. On paper, both revenue and expenses look inflated, yet the totals roughly match the incoming 1099-MISC forms. So nobody notices until a year with one unusually large settlement throws the margins off.
Cleaning it up usually means rebuilding trust activity matter by matter and tying each settlement deposit back to its 1099. (This is a composite of situations we encounter in practice, not any one client’s facts.)
If your trust deposits and your 1099s don’t tell the same story, it’s worth sorting out before your next return. Schedule a discovery call.
4. Why Does Accounts Receivable Slip at Law Firms?
Accounts receivable (AR) is the money clients owe for work your firm has already done. At many firms it grows quietly. Attorneys are often reluctant to press a client mid-matter, so billing gets pushed until the case wraps up.
Clear expectations at the start of an engagement help. ABA Model Rule 1.5 calls for the scope of the representation and the basis of the fee to be communicated to the client, preferably in writing. It also requires contingency fee agreements to be in writing and signed by the client. An engagement letter that adds billing frequency and payment terms gives your firm something concrete to point to once an invoice ages past 60 days.
Monthly statements help too. Firms that send them on a set schedule and review an aging report at the same time generally catch slow payers sooner. It shows how long each invoice has been outstanding. That makes it easier to decide when a balance needs a phone call instead of another statement.
Many small law firms use the cash method of accounting for taxes, which means unpaid invoices generally aren’t taxable until collected. AR still matters under that method, though. It represents cash your firm has earned and can’t yet use to cover payroll or rent.
5. Why Does Revenue Alone Misstate Attorney Profitability?
Revenue per attorney is the easiest number to pull, which is why many firms lean on it. The trouble is that it counts work billed rather than work paid for. An attorney with large invoices and slow-paying clients can look more productive than a colleague whose smaller matters collect in full.
Two of the key financial metrics for law firms fill that gap. The realization rate compares the amount billed to the value of the hours recorded. It shows how much time gets written down before an invoice goes out. The collection rate measures how much of what you billed actually came in.
Here’s how the two work together. Say an attorney records $200,000 of time, bills $170,000, and collects $150,000. Her realization rate is 85%, meaning $30,000 of recorded time never reached an invoice. Her collection rate is about 88%, meaning another $20,000 was billed but not paid.
Revenue alone would credit her with $170,000. Tracked by attorney and by practice area, these two ratios show where billed work actually turns into cash.
Reliable ratios depend on the earlier fixes. If trust funds are mixed into revenue, or advanced costs sit in expenses, any profitability report built on those books inherits the same distortion.
What Our CPAs at Fusion Work Through With Law Firms
Our law firm accounting team works on both sides of the trust line. On the accounting side, that includes monthly three-way trust reconciliations, retainer tracking, advanced-cost accounts by matter, and AR aging reviews. For firms that have outgrown a part-time bookkeeper, this work often sits inside our outsourced controller services.
On the tax side, our team prepares and files the firm’s own return. That’s Form 1065 for a law partnership or Form 1120-S for an S corporation. Before filing, the team reconciles incoming 1099-MISC forms to your trust records. It also prepares the 1099-NECs your firm owes to outside professionals.
Fusion CPA works with law firms across 40+ states, and you can find a Fusion CPA office near you. Our controller and tax teams can review how your trust records line up with your tax reporting, starting with a discovery call.
Sources and References
- Internal Revenue Service, Instructions for Forms 1099-MISC and 1099-NEC (Rev. December 2026)
- American Bar Association, Model Rule 1.15: Safekeeping Property
- American Bar Association, Model Rule 1.5: Fees
- State Bar of Georgia, Georgia Rules of Professional Conduct, Rules 1.15(I) through 1.15(III), and List of Financial Institutions Approved as Depositories for Attorney Trust Accounts (as of October 2026)
- Canelo v. Commissioner, 53 T.C. 217 (1969), aff’d, 447 F.2d 484 (9th Cir. 1971)
