Accounts Receivable Retainers vs Trust Retainers

Welcome to Accountants Law Pod, where accounting professionals and law firms converge, hosted by Linda Artesani, Sarah Prevost, and Steven Libhart.

Welcome back, everyone. We have a pretty interesting topic today that we'll dive into, but first, how are the two of you? How was your weekend? How was, how was life over the weekend for both of you?

Go ahead, Linda. I'll follow.

I worked.

So did I. Okay, back to Sarah.

Well, you know, the looming deadline coming up.

So yeah, here it is, early April, and it snowed on Saturday here, and then it's going to be 80 degrees this week. Colorado weather, I'll tell you.

You have crazy weather.

I thought—

We do. Yours is crazy.

Yeah, so it's not uncommon in the winter here you run around in shorts and a sweatshirt and a coat.

You know, because you just prepared for anything.

Layer. Well, segue into accounts receivable retainers versus trust retainers, because you have to know what you're doing.

Yeah, we get the layer there too.

You got a layer there too.

Now, this is going to be an interesting one to see, see how many people download it or watch it, because, yeah, I think the only person who's going to be searching for it would be somebody's like, oh my God, The client, you know, I got a prospective client and they said they might just ask me and like, what do I do with them? I'm like, logic will dictate, okay, if you've had a construction client, they get a deposit. You kind of look at it that way. But it's dangerous. That's all I can say. Danger, danger.

You brought up a good point because it's true. It is a deposit retainer like in any other business, like construction or Any type of thing. It's just when you layer software on top of it. So if you have like a Clio on top of it, or you have a LeanLaw or any, any practice management layered on top of the software and how to manage that, it's not very clear when you're looking through those programs.

Especially since the programs are designed for trust accounting. They're not designed for AR retainers. So, um, you're going to have to do a little bit of manual work when it comes to this. So know that when you price out a job, if the client says, oh, I've got AR retainers, but don't worry about it, it's not a big deal. It can be a big deal because if you've got a lot of money sitting on the balance sheet as an AR retainer, so negative AR, and then you've got not enough money in the bank to return all that to a client, there's a problem, right? You have to make sure you get enough money in the bank to cover that. You shouldn't have spent that money. You didn't earn that money. It falls under the same logic. As a trust account.

Yeah, it falls under the same logic, but it's almost backwards when you think of one, the trust retainer, and then you think of the AI retainer, and here's the attorney and their staff. They've got to kind of think backwards in looking at it. And I think you were starting to jump into maybe—

it's not articulated, it's not as—

Yeah, yeah.

Well, and I, I think it just hit me now, Linda, another idea to this, a tip that could be, is If, like you're saying, there's a certain— if you have it in your operating account, there's a certain threshold of what that dollar is. Maybe that's the dollars you move into a secondary checking account that's just called operating retention.

That would make sense, right? So now you can—

That makes more sense. Yeah.

Otherwise it's all muckied up in the operating account.

In the operating. Yeah.

If you— I just thought about— can you subaccount your bank? And but then there's all those reconciling problems. I know, I know. I'm just— but we're going to get those questions.

But you're right. I mean, yeah, that's a logical thing to think of. And you just know that it's messy. And then if you're getting it from another bookkeeper and you're looking at it, you're like, well, who does this belong to? Because it can, in theory, get dumped into a pile. Who hasn't picked up a balance sheet from a client, not just law firm, but any client? And there's this money sitting in a prepaid deposit account, and you're looking at it going, Who is this for? And you have really no way to figure that out. Like, security deposit account, just use that as an example, right? I've had that picked up a client or 2, and they're real estate, and they've got multiple properties, and there's money sitting there, and you can't— you gotta figure out who it belongs to, who got their money back, who— yeah, it's—

Yeah, it's an extra step. And so what you're bringing up is a very good point to bring up regarding software on top of it. So going back to that comment, You are not going to— like, if you're a bookkeeper, an accountant on the QuickBooks side, you probably have formulated in your brain how you would actually just do this. But however, you have software involved. That's not how that workflow is going to work. So you have to be okay with negative AR. You have to be okay with coming up with a workflow for validating the information, building custom reports. And I've done this. I'm speaking from experience, so I'm offering this as a tip. And I would never recommend that you make journal entries or add additional layers to it and moving it into these liability accounts for the sake of exactly what Linda brought up. You're going to get confused. You're going to miss the way that the workflow is going to be, and you need to uncomfortably be comfortable.

Yeah.

With this information and the reliable reports. And you look at those reports, you validate them per month, you go through them. So from our experience and my experience alone, I have Clio as the software. I'm working with a client who's in a certain jurisdiction that this is permitted. So the bar—

Here's the other thing. It's not always permitted, and you gotta make sure that it's okay.

Exactly.

And then, well, you know, just built the workflow to that.

It's the—

prior to the podcast starting today, we talked about that. I have never heard of that in my state. I'm gonna go looking this morning and—

Oh yeah, New York.

Yeah.

Notorious for it. So New York State, they—

there's other states that allow for it based on types of billing. So you have to really know what is allowed by the style of billing in the, the practice area.

So how would you explain to both the legal accountant/bookkeeper and the attorney the difference between an accounts receivable retainer and a trust retainer, which is usually the result of their accounts receivable. How would you explain that to them and educate them on that?

Well, they would actually explain it to us because they're the ones that would be holding it, because it does go by just what Sarah said. It's the type of work that they're doing.

Okay, so let's dive— well, tell me that.

Well, the typical work they would do, right? You, you go come in, you get high, you hire the attorney, divorce, and they say, okay, it's going to cost you X, I need a retainer of $10,000. You give them $10,000, that money goes into trust. That's different than—

I—

what kind of an immigration bill would be one that I guess you could do it on?

Operating retainers. We've seen operating retainers.

You could do it, I guess, with corporate.

Maybe it depends on the corporate, depends on the style of billing. I'm sure it depends on the jurisdiction too, like what's permitted. Um, so the way I think, Steve, is to Linda's point in your question description, The attorneys know. They know what these operating retainers are. They'll, they'll say it. They'll tell you this is how it works. They have 2 styles. We see a trust account that has a lot of activity, and then we also see an operating retainer style system. The problem with it is going back to the workflow and understanding what, how, what is that balance, and how much do we agree to? And we've seen a conversion. We've seen attorneys that have worked in what we call operating retainers unsuccessfully, and the state in which they're in has required them to make these trust retainers now.

And take them completely out of their retainers.

Okay.

Yeah. You gotta move the money over. You have to follow the money. It's a mess, and it's a problem to unwind.

It's— I love the idea about putting it in another bank, though. Now you've taken it out of the operating You're putting it in a place where it's separate.

Oh yeah.

A trust account. You're taking it out of operating so you can't accidentally spend money that doesn't really belong to you.

You got to be careful because I'm sure there's rules around a savings account versus an operating.

That was my next question. Yeah. What do they earn interest? What happens there?

I would, I would caution against putting it into a savings account for the interest earning because does that cross a jurisdictional line of clients? And should it now be deemed a trust? Because you're technically not supposed to make money off of a client's money, period. Right, right.

Which logically makes sense. Yeah.

Yeah. So what would a personal injury firm—

They wouldn't—

that would not—

that doesn't work, would it? No.

I don't think for us to figure out, because it is complicated, it's not for us to figure out which area, what A jurisdiction.

Right, right, right.

It's when you see it. We've inherited it. We see it. It explains. I can see, and I admittedly, it almost passed me by one day when it was being explained to me, and I was like, oh, okay. And I kind of figured out a workflow realizing, oh, no, no, no, no, no, no. I understand what's happening here. Back that little thing up there and redo it. I see a change with certain bar associations or the overarching rules. I can see where This might be changing based on the terms fixed fee, flat rate.

Yeah, with all the different billing.

Yeah, we heard it at Clio Con when we were there. There was a big conversation about it, but I can see where this needle is going to move and I don't know what sort of guidance it's going to provide.

Right.

Each relative space.

Fascinating. Fascinating.

Yeah, it's challenging because it's very manual. You have to do it manually. No software that I know of Maybe there is something out there that can track an AR retainer. But when you're working with, like, LeanLaw, Clio, that's not a feature set.

Yeah, you wouldn't post a credit to them, would you? You would in—

Yeah, you would.

You would in, like, Clio.

So here's the thing. If you're just in, like, a ledger system, like a Xero or a QuickBooks, there's a way that you would do this workflow. But when you add the other secondary layer on it, which is the practice management software, which honestly, that's what you should be in as a firm.

Yeah.

To come—

Exactly.

At this stage in the game, to come to any accounting firm without that, it really, it's kind of a red flag to us because we need something. We need some sort of balancing tool, and you need to be in a different software. You need the suit. Like Linda always has said, there's a suit in front of the ledger. But you have to be okay with a different workflow, and you have to be okay with figuring out better checks and balances based on billing cycle, based on how funds come in, based on how it's built. There's got to be a different bill. There has to be a different way for you to track it. You have to build out a whole secondary. It's more complex because it does rely on very good Diligent accounting bookkeeping work.

Devil's advocate here. Have you ever had a scenario where they're like, okay, the, the, their client has gobbled up the AR retainer, so now they're going to take the rest of it out of the trust retainer? Have you ever had that?

Yeah, yeah, it has. Yeah, of course. Yeah.

Okay.

I'm playing devil's advocate here for the audience, so. Oh, okay.

Yeah. No, I'm like, oh, that's good.

I'm trying to think if that's ever happened, but if you say so.

Yes, it has. I know of a client of ours that it has, that I've worked. You know, first we had to validate it. We found out it was exhausted. There were trust retainer funds, but again, it's the same workflow that you would normally do. Present the bill, state the information. You have funds in trust. You have to make sure the funds in trust— we've talked about it before on other ones. Some jurisdictions require you at minimum to send out a statement saying what, what is your funds in trust as a— from a firm to a client, right?

So another devil's advocate for you, um, in those jurisdictions where they're allowed to have an accounts receivable retainer, why, why would they want to do that? Why specifically?

Why would they want to be in regular trust and they don't have the bar on their back?

Yeah, it's that simple.

Yeah, because if you make a mistake there, you're not going to lose your license to practice.

So an attorney could be, let's say, in trouble with the regulatory agency. They could just convert over to these and—

Oh no, because—

oh no, devil's advocate here.

Yeah, there's rules around these because they have to follow with the type of work that they're doing and The process of it. So they just all of a sudden say, I'm not going to do this anymore. Otherwise, they would all do that. They don't use the trust at all. Everybody would be doing it, which is not going to happen. And I don't know, is there states— what states do you happen to know, Sarah, which states don't allow for AR retainers? Is California one of them?

I'm pretty sure based on the new rules, that's got to be. Yeah.

I wish I could remember that attorney's name that has rocked the world of California.

Maybe Sarah can put it in our show notes, but I think—

That changed everything. I mean, it is a slow change process over the years, but things have strategically been— rules have been implemented because of the fact that that attorney was also embedded with the bar and got away with a lot of things that you wouldn't typically get away with.

And yeah, you'd want to really tighten this down in the retainer, or excuse me, in the engagement letter then.

Well, and, and Steve, I, I think about this because Linda and I've talked about these things before, and she's done a lot of posting on this. It's about, you know, the flat rate, fixed fee, subscription style billing. And I know you've got some blog posts on this, and you know what we heard is, well, some firms are doing it that way so it gets— it sidesteps the compliance Regulatory description. But that's gotten savvy to different associations.

Subscription billing, right? So say you're a business attorney, and you— which is a genius way of doing it, and I forgot who.

Yeah.

So you're not paying— oh, we were talking about it with your vet wanting to cut the hair of your dog, right? And doing it for a lesser amount, but they're going to get that money sprinkled over the entire year. So the same thing with subscription level with attorneys, and that's a great model if you can do something like a gift certificate purchase. You're going to keep paying per month. And I wonder how that money lands, because if they're ongoing, it must have to go again to the regulations of the state and the type of work you're doing. But it doesn't— the chicken or the egg, right? With the services, nothing's done during the month. How does that— Reconcile? Is that just because it's a different style that they don't follow who did the work when?

Well, I would think my mind would think that. So you'd really have to understand what's— you'd have to track hours appropriately to make sure, even though you're not tracking hours because you're billing in this model, but you want to make sure that unbilled time against it is being tracked in some form. And if I recall, we were on with the client And they had mentioned that their promissory note or their billing— this was not even the client. This was on with a different— it was kind of a combination meeting, and you had to have like a different promissory note that stated how the billing would work.

Mm-hmm.

What are the, like, you know, the payment plans or the subscription plans? And it had to be its own document with its own signature. So it can't just be folded into the engagement. It had to be its own initial piece, a standalone product piece. And then there was something else that came to mind, and I think that at some point you also have to decide as a firm owner, where does this file, this client's file, stand in relation to the work that's being done and the future work? Maybe there's a court date that's pretty far out there, then you have to draw the line in the sand and decide, kind of to your point earlier, Steve, that money needs to go into trust because at this point no work's going to be done. We're on a pause moment and we need to hold this until a future date. You got to get really comfortable with doing all these extra pieces. And for accounting people, it's almost like we have to read your mind to follow the money.

We're not there and we don't know the ins and the outs of each case or matter. We don't get granular with them. And follow them, follow up with them. Yeah, I mean, it can get really sticky. I could see where that can be. And, you know, I understand the subscription method is, is a nice way for really for attorneys to have better cash flow, right? I mean, that's kind of a method that would work.

Oh boy.

Some practice areas, I don't see how you could do it.

I don't see how you could on any contingent one. I just don't see how that could be.

Right.

Because they get paid after the fact. Yeah. Yeah.

I don't know.

That's a good question. This is—

It reminds me of when I owned my day spa many, many years ago. We have— we had, if you will, a subscription service of prepaid services. And so you could deposit a certain amount every month and come in and have a discounted massage or facial or whatever. And we normally push that business to the newer employees to get them built up.

Yeah.

And, you know, when we sold that business, we had to sell that ledger of prepaid money. We had to include that in the sales transaction and outline it all and who it belonged to so that there was no disruption in service. Kind of reminds me of that. And that was a liability to us, for us.

And, and the rules around it's so different. I'm pretty sure, I mean, legal is very specific, but, uh, gift certificates versus memberships. I'm sure there's a billing differentiator just like we're talking about now.

Absolutely. Yeah.

And then you add the other pieces of layers to it of what's permitted, what's allowed. And, you know, when you're signing, like with— I think we brought up California earlier— when you're signing your annual renewal, it is like a Bible worth of stuff that you're attesting to.

Or the scenario which you guys brought up, immigration a little while ago, the scenario where, you know, one person is paying for another person's services. How does that play into accounts receivable retainers? And maybe that's a more clearer— more, excuse my word, workflow for that. Yeah, definitely.

You have to, you have to have checks and balances. It's same in, in family law because it's true of family law. Yeah, you think about You know, a case is happening, but somebody else is paying on behalf of an aunt and uncle, whatever it is, you know, and the names don't associate.

Or the names are the same. So you've got multiple names of the same, which makes it harder to track.

It is, it is not. It's not a straight line way of reconciling in a sense. It's part of a reconciliation monthly viewpoint that you need to be looking at. You're kind of reminding me of things that I need to just validate and verify with.

It's like, oh, I better go back and look again.

Just making sure we— I built very custom reports for this, and it's working. And it's also very confusing for the tax individual at the year end.

I was going to ask about that too. Yeah. Yeah.

It comes like a contentious back and forth conversation. I'm like, no, no, no, this is legitimately what it is. So Maybe there's a year-end entry that has to happen just for that purpose, or an explanation.

Well, yeah, do they consider it as a prepaid deposit, or is it a liability? Is it an asset? Is it, you know, what are they going to do with it on the tax return?

Yeah, well, most of them are, because that's cash basis. Most of them are cash basis, so they've got—

So think, but it's so funny, Linda, because we get this. And, and it sits the way it sits, you know, because it's getting booked in, and it's a— it's an extra layer on our side as accounting professionals to support the firm, just to ensure that it's being followed accurately, the money is tied to the right people, the additional layer of reconciling it, and then on top of that, having that conversation at year-end.

Yeah, you can't just leave it there and ignore it. It's going to be addressed with the attorney often because you need them to know that this money is there.

And I'm sure it's like unclaimed property too. If it's— if you have to return the funds, couldn't it follow the same?

I would think so.

We would think that's—

Yeah, I would think so.

That's another layer that we probably just need to make sure because it's like—

Which is always a fun time. Yeah.

It's not like I have the abundance of time and I'm going to do that. That's an idea. Sure, sure. Yeah, it seems so. You— so Lynn and I've had experience in it, not a lot. It's, it's not as common.

Okay, so can I jump in right there?

Yeah.

And have they been larger firms, smaller firms, anything? Any trends there with that type of work or that type of— okay, go ahead. I'm sorry.

No, I'm just saying for you, you haven't had that experience.

Yeah.

Think about if you try to, like, so it's kind of nice because we have the experience. So then you haven't. So if you're thinking about it as someone on the accounting side and you're being presented this information, how do you begin to tease this out? How do you begin to develop a workflow that you feel confident in offering in addition to just the regular stuff that you do?

Right, right.

It's a lot.

I can picture you, Steve. You get the balance sheet open up and you look and you see money there and you're going to go back to the client going, okay, what's, who Who owns this money that's sitting in here? And they're either gonna say, oh, it's on a spreadsheet somewhere, which guaranteed doesn't equal the balance that's in the bank account, or it's booked out that way, like a good bookkeeper booked it out so you can see the balances. So you have the 2 scenarios. But yeah, guaranteed it's more like the first one where you've got, oh, here's the spreadsheet. Like, excuse me, Mr. and Mrs. Attorney, this is not equal to this. Now what? What is the difference?

Now what?

Oh, it doesn't. You can hear it now. And then, yeah, you're like, oh, it should. Can you make it, make it be that way?

If you have like $50,000 in negative operating retainer, let's say I'll call it negative because it tends to sit negative in our— but you have $50K in operating retainer and your bank account says $45K.

That's a problem.

Where's the $5K?

Yeah, yeah.

I—

that's why I was thinking earlier, Linda, it's like It would make sense to me that it would be smarter if you're, if you're not as diligent about the funds in that operating account, it would be smarter for you to move those funds to a secondary just to get them out.

Even if—

Yes.

You know, like Steve was saying, a subaccount. But even if you got it out of the main account, because, you know, a lot of the clients, they, they go by what's on that, um, bank feed, right?

Yeah.

By that, they open that up. How many times have we answered, how come this number doesn't match this number? Well, you've got checks outstanding and deposits outstanding, but They look at that, and I noticed Intuit changed the way it looks on the new ones. It says posted amount now instead of saying QuickBooks balance, bank balance. And now it says posted, which is good for us because that thing was always troublesome where they're like, why is my QuickBooks— and that's one of the things, well, we look at, Sarah, when we look at a file, like, whoa, there's a problem here. You got $95,000 in the posted amount and the QuickBooks amount, and then you've got $320 in the bank account. Something's not right. And it could be just a lot of checks. I mean, we see that with immigration firms. There's a lot of checks out there that aren't cashed because they're at the Department of Homeland Security and they're just kind of hanging in limbo until processed. But for the most part, if you see something like that, something's wrong. It could be the client reconnected the bank feed and then it's got a reconciled opening balance entry in there that needs to be removed. I mean, it could be something like that.

I love the question that we get. I just start laughing.

Oh, I've heard that so many times.

How come this is negative and this is positive? Isn't that what's in my bank account? What's in this thing? And you know, this is the client.

I'm thinking, know, that we have always, always, always never had a bank feed experience. So now they like, by that number that's in there, like, it's like they are obsessed with that number because they've never had that ability of looking at it real time. And we have to explain to them it's really not real time because you could have written a check on Friday and it doesn't show up in your bank feed until Tuesday. I wrote a check for this amount. How come that number is— well, that's what the bank is saying right now if you logged in right at this moment.

Yeah.

And the bank feeds, always there's a delay.

There's pending, posting. But think about like your credit report.

Yeah.

Because you paid your credit card bill off, it doesn't happen like instantaneously that your credit report goes—

Nope.

Like a month later if you're lucky.

Always slow.

It's always—

Well, we have a client who's using bill pay through their bank and they, you know, forget to tell us that they wrote the check.

That's happened.

You know where I'm going with that. And so somebody, you know, gets the check, sticks it in a drawer, doesn't cash it, or they cash it 7 months later and all of a sudden see this transaction comes through and we're like, what is this?

That's always my concern when a client's moving from one bank to another with their trust.

Oh, yeah.

Because you don't know if they've handwritten something that's out there that's never been booked into the system.

Yeah. Well, probably looking at operating retainers is the percentage of the billing. How is it working? Because some people adopt, you know, they get— they start the process and then they adopted you know, a different billing style essentially.

Yeah.

And frequency of billing is also going to impact how this is going to work. But when you think about if you're reconciling all of these pieces and all of the diligence and then you have to move a bank or you have to move a ledger, you really, really need to have the ability to see, okay, what does this look like? What client is, you know, It depends on your volume. What client has what money in operating retainer that can be applied to a bill? How do you build those billing invoices to show what they have as a credit on file?

I think you're going to start doing this as an attorney, really best practices in place. Ask your accounting professional, what's my best practice? Because you really need to track this just like anything else. And I got to think that you've got to let the client know that this money is sitting there. And you can see this all the time where you've got All these negative balances, and it's like you've got to do something with it. Don't just leave it on the books.

You know what I was thinking while you were saying that? What if the client doesn't like that method and says to you, I want you to put this money in trust for the firm? Are you obligated in that area that has this offering? Are you obligated? Like, do you have to follow what the client's request is?

We had a client that did that all the time. They had the negative AR, and we said, what do you want to do with it? And they said, Move it into trust because they needed to get it off. They didn't want it negative AR. They wanted it in trust. That was a multilayered transaction moment to get that money out and out of negative AR and into the trust account. It's not a click, bang, boom. There's no buttons for that. No, that's a trust tricky transaction.

I love it. Wait, Linda and I make all kinds of sounds. I'm sure it's like going on. I mean, I'll have to listen to this one because I made a lot of bang, boom. Tricky Trust Transaction, TTT. Yeah, it's like dynamite.

Yeah, TNT.

Oh my gosh.

Wow, it's—

that's funny. We'll see. But I guess if you run into it, don't call us. You're on your own.

Run away.

I'm gonna check in the state that I'm in and, and see. I have never heard of that here in this state.

Look up New York because that is definitely a thing in New York. New Jersey too, I think. Both those states.

Yeah.

They don't have an IOLTA. They have an IOLA. So go look up just that. Use the little map we have from my case and click and find out.

Right. I remember that.

There's a whole section on that. You'll see what the rules are around that.

I want to know what size the regulatory agency offices are, how many staff they have in New York and New Jersey, just because of this.

I'll tell you something. This has come up on a cleanup. Oh, this is a subscription client. It shouldn't have gone. Well, sorry, the accounting person that you had on at the time in your firm put it in the wrong one, or the client paid with the wrong, and it went into trust, or it went into operating, and you're taking money out of trust because it didn't fit. So you're a firm that allows for it, but you have different types. You have to come up with a system to ensure that you understand What type of billing it is? They come up with some sort of numbering system. What style of? You can't just presume that you know staff in the firm is going to understand just by looking at it. Oh, that's this style of billing just by the name. That's do yourself some diligence there. But also, if you've taken money into the wrong account and then you find out later in a cleanup, it is what it is. Like. We're following what the bank account— you know what I mean?

So workflow, workflow, workflow. This is what it all comes down to when it comes to this. You've got to implement, figure out who it belongs to, and implement really good strong workflows around this so that it's very protected, just like a trust.

Yeah. Yeah. Okay. That's all I want to talk about on this.

I wonder how many people are going to need an aspirin after this recording.

I am curious what this is going to look like. Linda said in the beginning. So yeah, but wow, quick bang, big— yeah. Okay, T, take us away.

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You know, it's funny, I noticed that we're all wearing very neutral colors today.

I know, huh?

I'm like, this was a spicy conversation. We should have been in bright, bold colors.

We should have.

Yeah, but we, we just quietly coordinated without coordinating.

So.

Well, next week is propeller hat week. We all should wear hats with propellers on them. Okay.

I don't need to wear glasses too. Yeah. Glasses.

Yeah. Oh, thanks everybody.

Oh, thank you. Bye-bye. Bye-bye.