Law Firms Must Review Trust Accounts Before Year-End

Law firms must review specific accounts before December 31 to ensure clean records for their CPAs and avoid issues with the IRS. Trust accounts are a primary focus, as the IRS analyzes the source of remaining funds, especially when the balance is high. Your CPA needs clean revenue and expense records, but the firm must also account for money that belongs to clients or passes through the business on someone else’s behalf.

Trust Account Reconciliation

Start with the December trust reconciliation. Your adjusted bank balance, your trust account records, and the total of individual client ledgers should agree. The word adjusted matters because a December 31 bank statement may still include checks that have not cleared or exclude deposits that were in transit at month’s end. If you have reconciled the trust account every month, December should confirm work already done throughout the year. If you have not, year-end can turn into a reconstruction project.

This is where you may find issues such as a deposit that was never assigned to the correct client, a transaction recorded to the wrong matter, or a trust balance carried forward for months without anyone asking why it is still there. Don’t stop because the bank reconciles. A bank account can reconcile while the client-level trust records are still wrong. By December 31, you should be able to show exactly whose money makes up the trust balance.

Outstanding Checks and Advanced Costs

Pull the firm’s “outstanding check” list and age it. A trust check that has not cleared still affects the reconciliation, and an old one needs more than an accounting adjustment. Maybe the client moved and never received a refund, or a medical provider never deposited a settlement check. Perhaps the check was lost and needs to be reissued. Whatever happened, don’t treat an old trust check the way you would an old operating check. The underlying funds are not automatically available to the firm because the check went stale. Determine who is entitled to the money, document your attempts to resolve it, and follow the applicable state unclaimed-property requirements when the owner cannot be located.

For contingency firms, advanced case costs deserve a separate year-end review. Filing fees, medical records, expert witnesses, deposition costs and similar expenses can materially distort the firm’s financial statements when they are recorded incorrectly. The IRS Attorneys Audit Technique Guide says cash-method attorneys generally may not take a current deduction for client expense advances when they expect the client to reimburse them. In those circumstances, the advance is treated more like a receivable or loan than an ordinary operating expense.

That means putting reimbursable case costs on the P&L can make the firm appear less profitable even though those costs are expected to come back when the cases resolve. The tax treatment is not identical in every arrangement, and the year-end job is to identify what is sitting in the books, confirm that advanced costs have been recorded consistently with the firm’s fee agreements and tax treatment, and give the CPA a clean schedule to review. If amounts being carried as reimbursable costs are no longer collectible, flag those separately instead of leaving them buried in the asset account indefinitely.

Liability Balances and Unearned Fees

Every liability entry on the general ledger should reflect a genuine obligation the firm holds at year-end. These items include client trust liabilities, unearned fees, settlement-related amounts, and any other balances that accumulated during the fiscal year.

Information Reporting: W-9 Collection and 1099 Filings

Attorney-service payments are generally reported on Form 1099-NEC when the amount meets the reporting threshold, regardless of the recipient’s corporate status. In contrast, gross settlement proceeds paid to an attorney are reported on Form 1099-MISC, Box 10, once they exceed the applicable limit. These rules are distinct; applying the wrong form can trigger an audit finding.

Final Checklist for the CPA

By the close of December, the firm should have a reconciled trust account, a reviewed list of outstanding checks, and verified liability balances. The W-9 and 1099 files need to be complete and organized for the upcoming filing season.