Escrow vs. IOLA Accounts: What’s The Difference?
A common question that befuddles New York attorneys is what exactly is the difference between an escrow account and an “IOLA”?
New York attorneys are often entrusted with managing client funds, such as settlement proceeds, that are held in trust. There are two common types of accounts used for this purpose: an Interest on Lawyer Account (IOLA) and an escrow account. Although both accounts are used to hold client funds, there are differences between them.
As we discuss below, the interest earned on funds maintained an IOLA benefits our fellow New Yorkers. We strongly encourage our clients to use IOLA accounts when possible. In 2021 alone, the IOLA fund assisted over 6,500 veterans and 26,000 victims of domestic abuse.
Interest on Lawyer Accounts (IOLA)
An IOLA is a type of interest-bearing checking account used by New York attorneys to hold client funds. IOLAs are established by the New York State Unified Court System and are available through various banks and financial institutions. The purpose of an IOLA is to generate interest on funds held in trust for clients, with the interest being used to fund legal services. In turn, the IOLA fund helps low income people in New York State obtain help with civil legal problems affecting their most basic needs, such as food, shelter, jobs and access to health care. The IOLA fund’s revenue is driven by the prevailing interest rate.
One of the main benefits of an IOLA is that it allows attorneys to hold client funds without having to calculate and distribute interest payments to individual clients. Instead, the interest earned on the account is pooled and used to fund legal aid programs throughout the state. This means that attorneys can focus on their legal work without the added burden of managing interest payments.
Monthly maintenance charges for your IOLA account are deducted from earned interest. You are responsible for paying other fees, such as check-book printing, wire transfers, stop payments, and NSF fees. If you have an operating account at the same bank, they may arrange for fees to be taken from that account. Alternatively, you can deposit enough funds into your IOLA account to cover fees before they are charged.
Escrow (a/k/a Trust) Accounts
An escrow account is also used by attorneys to hold client funds in trust, but unlike an IOLA, a typical escrow account is not interest-bearing. However, attorneys also have the option of maintaining funds in a non-IOLA interest-bearing escrow account. The accumulated interest from that account is credited to the individual client’s account and can provide a small return on investment. Of course, interest-bearing accounts are typically used in situations where the client expects the funds to be held in trust for an extended period of time, such as when attorneys are engaged in a protracted fee dispute over a substantial legal fee.
Compared to IOLAs and escrow accounts, interest-bearing trust accounts offer the added benefit of earning interest on the client’s funds. However, like other trust accounts, attorneys must ensure that they are complying with ethical and legal requirements when using interest-bearing trust accounts, such as disclosing the interest rate and any fees associated with the account and ensuring that the interest earned is credited to the correct client.
When should I deposit funds into an IOLA?
As discussed above, for larger amounts or funds that are expected to be held for an extended period of time, attorneys often choose to deposit those funds in an interest-bearing account in the name of, and for the benefit of, the client. This can provide the client with an opportunity to earn interest on their funds while they are being held in trust.
However, when it comes to smaller amounts or funds that are only expected to be held for a relatively short period of time, it may not be practical to establish a separate interest-bearing account. In these cases, attorneys in New York should use IOLA for the deposit of such “qualified funds.”
One of the benefits of using an IOLA for small or short-term deposits is that it can help to avoid administrative costs and tax liabilities that may otherwise be incurred if the funds were held in a separate interest-bearing account. In some cases, the costs associated with maintaining a separate account may be greater than any interest that could be earned on the funds.
It is worth noting that the determination of whether funds are “qualified funds” is left solely to the discretion of the attorney who holds the funds in trust. This means that attorneys must exercise good judgment when deciding whether to deposit funds into an IOLA account, and must ensure that they are in compliance with all ethical and legal requirements.
However, attorneys in New York are protected from liability if they deposit funds into an IOLA account in good faith, thanks to a statutory hold-harmless provision. This provision ensures that attorneys will not be held liable for damages or professional misconduct if they make a good-faith judgment that the funds qualify for deposit into an IOLA.
Conclusion
In sum, while interest-bearing accounts may be preferred for larger amounts or long-term holding, IOLA accounts offer a practical solution for small or short-term deposits and help support a good cause. Attorneys must exercise good judgment when deciding which type of account to use, and must ensure that they are in compliance with all ethical and legal requirements.
Please note that the information provided on this website is for general informational purposes only and is not intended as legal or tax advice. The information is subject to change, and it is important to consult a specialist before making any decisions. Law Ledgers provides accounting services to New York lawyers and law firms, including escrow protection, tax advice and bookkeeping administration. Contact us today for personalized support.
