Law firms pay filing fees, investigator costs, and medical expenses upfront for clients, but the IRS treats these as temporary loans, not income. Recording them wrong distorts profitability and creates tax problems. Set up a separate Advanced Client Cost account and reconcile monthly, ideally using software like LeanLaw or Clio that syncs with QuickBooks.
Chapters
This week we're going to talk about advanced client costs and how to manage them when you work with attorneys and law firms. I can tell you over the years of working with attorneys that I've seen it all. I've seen some attorneys not really track it and not really care too much about it, not follow it. I've, I've seen some firms put it in as expenses and then take it out as income when they, when they bill the client back, which is kind of the old-school method. The IRS wants to see it as a mini loan, which is what it is. The law firm's using operating capital. This is when it's operating only, and it's using the funds to pay for client costs up front and then billing later. So they bill once a month and they bill for any costs that occur and were incurred during the month. So they're in essence loaning the client a little bit of money, and then they're— And then they're getting repaid for it. So the, the IRS is like, we don't want to see this. So we don't wanna see this on the books as an income or an expense because it's really neither. It's a temporary loan, it's a temporary loan to the client. So once you understand that, arm yourself with the part of the IRS Code that explains that when you attempt to go to an attorney and correct it if it's not being handled properly on the books. Sometimes you'll get into the client's books and see that it's, this account's never been reconciled. So advanced client cost is an asset account. You'll see that it's never been reconciled, and there's funds in it that may have been, may or may not have been billed back. It needs to be reconciled. So you know exactly which fees are still on there that have not been billed. It's, it's really a critical part of the bookkeeping flow, because if not tracked properly, a law firm will absorb that expense and not make the funds back or be reimbursed for it. So if you think of it in that manner, it's a very important task and it's a very important part of the workflow. The easiest way I know in the beginning when I used to use this HubDocs, like $12 a file, you pay for that cost, you include it in your fees with the, with the law firm workflow, and then you just have the client upload all the expenses into there. You code them to advance client costs. If you have the right billing software like LeanLaw or Clio, you are going to be able to see that be billed back and you're going to track it beautifully and everything's going to be fine. So the problem comes into effect is when the client hasn't had that workflow and you're stepping in and you're trying to make the correction to the workflow and you've— maybe they've expensed everything already, so they've actually written it all off. And this is where you're going to need to have a good conversation with the tax professional. If you treat that as an expense, it's kind of skewed the law firm's profitability. It's in essence lowered it, and then when they do bill back to the client, it's going to inflate their income. It's so it's going to really throw off the actual numbers, the actual amount of money made in, in service of their work. So there may be a correcting period as you start to adjust the way the workflow looks. Know that this process can take time, might even take a full year to have it corrected. Really starting with looking at what's there. If they're using income and expenses, try to stop that practice and move forward into the future using the Advanced Client Cost Account. And then you will reconcile that monthly. And it's something you need to put in your practice management tool to remind you to reconcile it monthly. It's not a task that will happen automatically. You're not gonna get a bank statement in the mail. What you want to do is look at it, and there's two ways of reconciling. You can reconcile to zero or you can reconcile. So reconciling to zero is just ticking and tacking off expense, income, expense, income. So you're getting rid of them as you go. Or you reconcile to the expense totals that are inside of, for example, LeanLaw. You're gonna see the expenses total in LeanLaw. That should equal the expenses total that's in your advanced client cost. That's your work in process, your WIP, waiting to be billed. That's easily done that way. So what are advanced client costs? I guess I should kind of roll it back a little bit onto that. Advanced client costs are your client costs, filing fees, investigator fees. It depends on the practice area. There can be many different types of fees that the client is paying for upfront. Now, in some jurisdictions, some law firms can actually pay, they can collect a retainer and pay out of that retainer for those fees. Depends. So if you start to see that, don't be alarmed. It could be that that's allowable in that state or that jurisdiction where your client is practicing law, and that they can take the— that money right directly out of the retainer and pay the fee. In that case, it's not advancing anything. It's using their funds to pay for it. So it just comes directly out of the client trust, and you will see it. So if they're taking and paying a filing fee out of retainer, it's gonna just hit the retainer. You can make a note that it was filing fee that you were paying for. But they're paying their own expense. It doesn't really matter what that was for other than notating what it, what you were paying. But really maintaining and categorizing these expenses is critical. Personal injury attorney comes to mind right away because they just have a boatload of expenses. They could have anything to do with an injury where there can be medical fees and things of that nature that the client is upfronting. And if they don't win the matter, guess what? They don't get any of that money back and it becomes a complete loss on the, on the law firm. Most of the PI firms that we work with win most of the matters that they— or they work something out with the insurance company, they get reimbursed for it. And sometimes there's writing down to do. So know that you'll see that there'll be write-downs. They may have to write off some expenses. They may not be able to recoup them in court. So just note— notate that. Make sure you take lots of copious notes when you're working with attorneys anyway to ensure that you have compliant, accurate accounting practices and dealing with the details of all of these costs. If you work with a PI firm, your client may be bringing the matter to court really after many years, and they may say, let me see what you have on the books for expenses. And this is where you're going to want to have that beautifully laid out amount of, of detail for your clients so they can make sure that all the expenses are captured. Most of them kind of have a budget when they look at— they know, they do this over and over repeatedly. They have car accidents, they know exactly what they're going to see, or you know, motorcycle accident is X or whatever, and they'll have all of the— an idea of what the expenses are going to be. And you really want their eyes on it before the matter closes so that everything's perfectly done. They might notice something's not there. And then this is where, if you have a Hubdoc or a Dext, you're going to be able to go in and really look at the details because you'll be able to pull those right off the transaction. You're going to code those transactions to advanced client cost, even if you're uploading them to QuickBooks. Code them, they, they'll be able to click on the transaction and see the details, which is really important too. So I hope this helps really get the client to maintain their records in the manner that the IRS guidelines provide. Advanced client cost is an asset account. So you want to have that set up in the books as such. If you're using Clio, you're using LeanLaw, that will connect the advanced client cost. Both of them have a two-way sync. So it's gonna read that data as you book it in, and it's gonna have it sit and wait for the client to bill back, which makes a beautiful workflow. No software, you're gonna have to go into the settings in QuickBooks, turn on tracking for any expenses to the customer level. You'll have to have some sort of QuickBooks that's Plus or above, and then you're gonna be able to pull that very manually. I really don't recommend that. And Clio has an actual personal injury module that's built for this purpose. And it's really, I think, worthwhile because it's kind of a baked-in template. So I don't know why anybody wouldn't wanna use that as a feature. And I think if you start to look at that as a law firm, or you can guide your attorney-client to that, you'll have a happy client. You're going to show you know your stuff when you're talking to them. And I honestly assure you that you will be able to shine above most bookkeeping services that don't know the details that we know, which is why you're here at the Accountants Law Lab. I hope you join us. And until next week, bye now. Bye.
