Managing a law firm is no small task. When things get busy, it’s easy to overlook one of the most critical aspects of running a law firm…your accounting. And many solo and small law firms unknowingly make accounting mistakes that can lead to cash flow issues, tax problems, and compliance risks.
The good news? These mistakes are preventable once you know what to look for.
Below are some of the most common accounting mistakes law firms make (and practical ways to fix them).
1. Failing to Separate Business and Personal Finances
Many solo attorneys and small law firm owners make the mistake of mixing personal and business finances. This can lead to:
- Tax issues – Improper expense tracking can cause problems with deductions and IRS audits.
- Confusing bookkeeping – It becomes harder to track revenue, expenses, and cash flow accurately.
- Limited liability protection – If your business is an LLC or S-Corp, mixing finances could jeopardize your legal protections.
✅ Fix It:
- Open a dedicated business checking account and credit card for your firm.
- Pay yourself through an owner’s draw or salary instead of using firm funds for personal expenses.
- Use bookkeeping software to keep track of all transactions in one place.
2. Mishandling Trust Accounting (IOLTA Violations)
Trust accounting (IOLTA) is one of the most common and serious accounting issues law firms face. Mismanaging client trust funds can lead to ethics violations, fines, and even disbarment.
🚨 Common Trust Accounting Mistakes:
- Failing to keep client funds separate from the firm’s operating funds.
- Using trust funds before they’re earned (commingling funds).
- Not reconciling IOLTA accounts regularly.
✅ Fix It:
- Use a separate IOLTA trust account (never mix it with your firm’s operating account).
- Keep detailed records for each client’s trust balance and transactions.
- Reconcile your trust account every month to ensure accuracy.
- Consider hiring an accountant with experience in law firm trust accounting.
3. Not Keeping Track of Accounts Receivable
Many law firms lose thousands of dollars each year because they fail to track who owes them money and when payments are due.
🚨 Common Issues:
- Sending invoices too late or not at all.
- Forgetting to follow up on unpaid invoices.
- Not having a system to track overdue payments.
✅ Fix It:
- Bill clients immediately after completing work instead of waiting until the end of the month.
- Use automated invoicing software (like QuickBooks or Clio) to track outstanding invoices.
- Set up automatic payment reminders for overdue accounts.
- Offer multiple payment options (credit card, ACH, online payments) to make it easier for clients to pay on time.
4. Ignoring Financial Reports
Your law firm’s financial reports are like a roadmap for your business. If you’re not reviewing them regularly, you’re making decisions without fully understanding your financial health.
🚨 Common Oversights:
- Only looking at your bank balance instead of financial statements.
- Not reviewing profit and loss (P&L) statements or balance sheets.
- Ignoring cash flow reports until there’s a problem.
✅ Fix It:
- Review your financial statements at least once a month to monitor revenue, expenses, and profitability.
- Track key financial metrics like cash flow, accounts receivable, and profit margins.
- Work with a bookkeeper or fractional CFO to help interpret reports and make strategic financial decisions.
5. Poor Expense Tracking
If you’re not tracking your law firm’s expenses properly, you could be:
- Overpaying on taxes because you’re missing deductible business expenses.
- Losing control over your budget by not knowing where your money is going.
- Making tax season more stressful because you have to scramble for receipts.
✅ Fix It:
- Use an expense management tool (like QuickBooks, Xero, or Expensify) to track expenses automatically.
- Categorize expenses correctly (e.g., office rent, legal research, travel, marketing).
- Keep digital copies of receipts to simplify tax prep and audits.
6. Choosing the Wrong Tax Structure
Many law firm owners set up the wrong business entity or fail to adjust their tax strategy as they grow. This can lead to higher taxes and missed deductions.
🚨 Common Mistakes:
- Operating as a sole proprietorship when an S-Corp would save on taxes.
- Not optimizing tax deductions for business expenses.
- Missing out on retirement savings tax benefits.
✅ Fix It:
- Consult with a tax professional or accountant to determine the best entity type for your firm.
- Take advantage of legal tax deductions such as home office expenses, CLE courses, and bar dues.
- Consider setting up a Solo 401(k) or SEP IRA for tax-advantaged retirement savings.
7. Not Budgeting for Taxes
Many law firm owners focus on day-to-day finances but fail to plan ahead for quarterly and annual tax payments. This can lead to last-minute scrambling, penalties, or even cash shortages when taxes are due.
🚨 Common Mistakes:
- Not setting aside money for estimated quarterly taxes.
- Underestimating tax liabilities and getting hit with unexpected tax bills.
- Forgetting about self-employment taxes or state/local tax obligations.
✅ Fix It:
- Set aside at least 25-30% of your income for taxes in a dedicated tax savings account.
- Work with a tax professional to estimate and plan for your quarterly tax payments.
- Use tax planning strategies (like retirement contributions and deductions) to reduce your taxable income.
Final Thoughts: Accounting Mistakes Can Cost Law Firms Thousands
Accounting mistakes may seem small, but they can add up to serious financial and legal consequences for law firms. The good news? With the right systems, tools, and financial guidance, you can avoid these pitfalls and set your firm up for long-term success.
P.S. – At America’s Bookkeepers & Advisors, we help solo and small law firm owners build a more profitable and successful practice with our bookkeeping and advisory services. Contact us today to learn more.
Check out our recent blog post about How to Improve Your Law Firm’s Cash Flow Without Raising Rates. You can read all other blog posts here.