Do-it-yourself accounting: sole practitioners and small-firm lawyers must also be businesspeople, and basic accounting is a key skill.

Running your small law practice as a business is essential for success. Standard business practices like good accounting can often seem less important than pursuing cases that could right an injustice. Yet managing money well is fundamental to good business practice--especially given the monetary risks lawyers regularly undertake.

We get paid only if we succeed, we advance all expenses that we cannot write off on our taxes, and we carry those expenses--sometimes several hundred thousand dollars in a complex products or medical malpractice case--for years without charging clients any interest. If we lose a case, our expenses probably will not be paid back. And to make matters worse, many federal and state lawmakers want to cap our clients' recovery, limit our fees, and close the courthouse doors by preempting certain claims. Some states have already placed these hurdles in our path. A person running any other type of business would avoid every part of this scenario.

What makes law office accounting different from that of other businesses is that if you do not think ahead about how to control and separate your practice's and your clients' money--that is, the fine points of trust, or escrow, accounting--you can be suspended, disbarred, or sent to jail. As a result, small-practice lawyers often must master both the law and bookkeeping.

Several commercial software programs, including QuickBooks and Quicken, can help you handle multiple accounts and code items for tax purposes. QuickBooks, which I use, provides a general list of expense and income accounts that you can customize. It can create a payroll, track invoices and expenses, and record hours spent on each case.

QuickBooks can also create a report that lists each disbursement separately, including filing fees and fees for obtaining medical records. The program provides a record of any check you send out, and it can track expenses paid by credit card: You simply post the amount of each month's statement in the program.

You cannot merge your money with that of your client, so you need at least two bank accounts: one for the practice and one for client funds. The client account is used exclusively to process payments from verdicts and settlements and to make payments to cover client liens, your disbursements, and your fees.

The perfect client trust account has a balance of zero: If you are paid a retainer, this money must stay in the client's trust account until you earn the fee and bill the client. Do not move money out of this account without a bill for services or an accounting sheet showing exactly why the money is being disbursed. You must prove entitlement to every penny in this account.

Use the firm's business account to pay rent, library costs, fees for online research, and other operating expenditures. I use QuickBooks to allocate the payments to specific expenses.

You may also consider setting up a separate account for client disbursements. Client disbursements include money your client has paid to yolk to expenses or money you advance for your client's expenses. An advantage of QuickBooks over Quicken is that you can calculate the amount of each client's expenses without a separate disbursement account. Using Quicken without a separate account gives you only a total disbursement figure for all clients combined, with no way to distinguish among them.

A client-disbursement account that's separate from the escrow or trust account has other benefits as well:

* You can decide how much money you want to transfer into the account.

* You can give more people in your office check-signing authority, as they can spend only the money in that account. As a result, your staff can file papers in an emergency or obtain medical records or police reports in your absence, and you won't be asked to sign checks while you're working on your closing arguments at home.

* You can maintain confidentiality: Employees who have access only to this account cannot find out what other employees are paid or what your rent is.

One potential disadvantage of this account is that you may wonder where all the money is going, as there will usually be many payments recorded. But that will ensure you are involved in your practice's accounting--and it may help you decide whether to take on a case.

Handling the payroll

You may consider adding another bank account--for payroll. If you opt to do payroll accounting yourself, you will need to calculate proper income tax withholding and make timely federal tax payments, either quarterly or monthly, depending on the size of your office payroll. You will also have to pay your share of each employee's Social Security and Medicare contributions, as required by the Federal Insurance Contributions Act (FICA). (1)

For the 2004 calendar year; Social Security withholding is 6.9 percent on wages up to $87,900; Medicare withholding is 1.45 percent, with no limit. These amounts must be withheld from each employee paycheck, along with applicable federal and state taxes. You, the employer, match the Social Security and Medicare withholdings.

If you do your own payroll, you will also have to file the required quarterly and yearly federal tax reports--forms 940 and 941, respectively--which tell the government how to allocate the tax monies you and your employees paid. At the end of the calendar year, you must issue W-2 forms to your employees and 1099 forms to any non-corporate party you have paid more than $600 that year. Anyone attempting to do payroll for him- or herself should consult the applicable federal tax guidelines.

If you are not comfortable acting as tax accountant for your practice's payroll, you can use a payroll preparation service such as ADP or Paychex, commercial vendors that will handle part or all of your payroll matters. Under a "full service" arrangement, payroll companies will write all your paychecks and prepare and send your tax reports; all you do is provide them with employee hours--designating sick, vacation, or regular hours for each--and ensure that your payroll account has enough funds to cover the checks and your share of employees' taxes. You can report the hours on Monday, for instance, and by Wednesday the checks are in your office. You need only sign them.

Having a payroll service do everything for you has several advantages. A team of professional accountants handles your involvement with federal and state tax authorities. All tax deadlines are met, and the service is responsible for mistakes it makes.

Electronic banking

E-banking is quick and easy: You can make payments without writing checks, even for recurring expenses. You can also link your accounts so you can easily move money from one account to another. E-banking also allows your employees to have their wages automatically deposited in their bank accounts.

Electronic banking has the added advantage of creating records that show your tax preparer where funds originated. When a case is settled, you have a paper trail showing expenses recovered and attorney fees earned. That makes the tax preparer's job easier and decreases his or her bill.

If you file your own tax returns, e-banking's paper trails will ensure that you don't pay taxes on funds paid to reimburse you for case expenses.

Another aid in accounting is making separate checks Out of your escrow account, whether through e-banking or physically, for your fees and expenses. If you are audited by state licensing officials about alleged trust account discrepancies, the faster they can see there is no impropriety or mingling of client funds, the quicker the audit will end positively.

The trust account

The client trust account is the most important one you have. In Massachusetts, recent misconduct complaints against lawyers for inadequate record-keeping have shown a steady increase. (2) Inadequate keeping of financial records usually starts with a bounced check drawn from the escrow account. In New York, banks are required to notify the state's Office of Professional Conduct when this happens.

In 2003, the Massachusetts ethics rules were revised to describe in more detail record-keeping requirements for trust accounts. (3) The new rules clearly describe the trust-account records lawyers must maintain--including check registers, individual client ledgers, and reconciliation reports every 60 days. The state prohibits making checks payable to "cash" or using prenumbered checks from these accounts.

Other states have long had specific record-keeping rules about client trust accounts. (4) New York, for example, has particularly detailed rules, incorporating basic parameters set forth by the American Bar Association (ABA) Model Rules of Professional Conduct (5) and establishing specific requirements for setting up separate accounts, even how to title them. Because they are even more comprehensive than the ABA rules, I advise using the New York rules as a guide, especially if your own state's rules are not as specific or helpful.

The New York rules, for instance, allow funds to be deposited in order to pay account charges, provided that no funds are withdrawn for attorney fees if they are disputed by the client or a third party. New York law has held that a third party can bring a lien against your client's money for medical bills, welfare, and other payments. (6)

In addition, New York requires lawyers to maintain the following records for seven years:

* all records of deposits to and withdrawals from the trust account, identifying the date, source, and description of each deposit as well as the date, payee, and purpose of each withdrawal

* records showing the sources of all funds in client-specific trust accounts and the names of all persons for whom the funds are held

* copies of all retainer and compensation agreements with clients

* copies of all statements to clients or other parties showing the disbursement of funds to them or on their behalf

* copies of all bills rendered to clients

* copies of all records showing payments to lawyers, investigators, or other individuals for services rendered or performed

* all check stubs, bank statements, prenumbered canceled checks, duplicate deposit slips, and other bank records showing the operation of the lawyer's practice

* identification of all authorized signatories.

The New York rules allow lawyers to provide copies of required documents, including photocopies, microfilm, optical images, or any other medium that accurately preserves the image of the document and cannot be altered without detection.

New York also has specific requirements regarding bank and other records that are subject to production in disciplinary investigations and proceedings. (7) A lawyer may be subject to disciplinary proceedings if he or she does not produce the requisite office records in a random compliance search, or if the documents are not kept according to the state's rules. New York courts routinely determine the severity of punishment according to how poorly the lawyers kept the required records.

When you became a lawyer and joined or started a small practice, you may not have realized that you also became a bookkeeper, charged by state licensing boards, state taxing authorities, and the federal government to do proper accounting on behalf of your clients.

Staying involved with your practice's accounting--whether you do it yourself or closely supervise a professional bookkeeper, payroll service, or accountant through quarterly meetings--shows you the real costs of operating your practice and ensures that you don't mismanage your or your clients' money. The more distant you are from the bottom line, the easier it is to buy that extra set of books you really don't need or to lose track of your day-to-day expenses.

A clear view of your practice will help you determine when and how to delegate accounting matters to others. No matter who does your accounting, your participation is essential because you are ultimately responsible. Notes

(1.) If you opt to do payroll on your own, see the following online resources: the Department of Labor (www.dol.gov), Social Security Administration (www.ssa.gov), and Internal Revenue Service (ww.irs.gov). Contact your state's taxing authority for information on state taxes.

(2.) Press Release, Massachusetts Supreme Judicial Court, Supreme Judicial Court Approves New Ethical Rule on Lawyer Accounting (Sept. 4, 2003), available at www.mass.gov/courts/press/ pr090403.html (last visited Dec. 9, 2004).

(3.) MASS. RULES OF PROF'L CONDUCT R. 1.15, available at www.state.ma.us/courts/ rule 115.pdf (last visited Dec. 9, 2004).

(4.) See e.g., N.Y. LAWYERS CODE OF PROF'L RESPONSIBILITY DR 9-102, available at www. nylawfund.org/pubs/cle.pdf. See also CAL. RULES OF PROF'L CONDUCT R.4-100, available at www.lectlaw.com/files/att12.htm. (All last visited Dec. 9, 2004.)

(5.) MODEL RULES OF PROF'L CONDUCT R. 1.15, available at ww.lectlaw.com/files/att12. htm (last visited Dec. 9, 2004).

(6.) N.Y SOC. SERV. [section] 104-b (McKinney 2003).

(7.) N.Y COMP. CODES R. & REGS. tit. 22, [section] 1200.46 (DR9-102) (2000).

RICHARD S. BINKO practices law in Cheektowaga, New York. The views expressed in this article are the author's and do not constitute an endorsement of any product by TRIAL or ATLA.