Trust accounting, tax, and cash flow guide for Australian law firms

Published Wednesday 10 September 2025

Table of contents:

• Understanding trust accounting obligations for Australian law firms
• Trust account setup and management essentials
• Three-way reconciliation: The cornerstone of trust accounting
• Trust accounting software solutions for law firms
• Tax implications of trust account management
• Cash flow management with trust accounts
• Compliance monitoring and reporting requirements
• Common trust accounting challenges and solutions
• State-specific requirements across Australia
• Technology integration and automation opportunities
• Streamline your trust accounting with Xero
• FAQs on trust accounting for Australian law firms

Key Takeaways:

• Trust accounting ensures proper separation and management of client funds in accordance with Australian legal profession rules
• Three-way reconciliation processes are mandatory for maintaining trust account compliance and avoiding regulatory penalties
• Specialised trust accounting software can streamline compliance while providing better visibility into cash flow and tax obligations
• Regular monitoring and reporting help law firms maintain good standing with legal profession boards and optimise financial performance

Understanding trust accounting obligations for Australian law firms

A trust account is a special account where a law firm - as a trustee - manages assets or funds on behalf of a beneficiary. These assets can include money, property, stocks and other investments.

Trust accounting is a form of bookkeeping used by trustees to track these assets held in the trust and make transactions on behalf of the beneficiary.

A trustee must manage a trust according to the terms of its deed, including:

• Supporting beneficiaries to select the right type of legal trust account
• Depositing money received by the beneficiary or beneficiaries into the trust
• Withdrawing money from the trust to pay expenses, transfer funds, or make other payments
• Keeping record of all transactions through individual ledger accounts
• Using three-way reconciliation to verify balances and transactions

Keeping client money separate from your own business funds as a trustee is crucial to protect the interests of beneficiaries and maintain trust account compliance.

In Australia, trust accounting is governed by strict national regulations to ensure client money compliance. In some cases, state-based rules also apply.

Non-compliance to national and specific state regulations can result in serious penalties, including fines, licence suspension, or legal action. For this reason, trustees may use trust accounting software as a tool to minimise risk of penalty.

Trust account setup and management essentials

The process for legal trust account setup first requires the beneficiary to choose the type of trust that best suits their needs, and draft and execute the trust deed.

These steps are usually carried out with professional advice.The deed appoints the trustee(s) to manage the account.

Following this, a ‘settlor’ - usually someone independent from the trustee or beneficiary - signs the deed and pays a nominal sum to settle the trust account and make it legally effective.

As a trustee, you will:

• Sign the deed to accept the role of trustee - in some cases, this may require a witness
• Receive the settled sum from the settlor
• Acquiring a Tax File Number (TFN), and if required, and Australian Business Number (ABN) through Australia’s Business Registration Service
• Pay stamp duty, if required
• Open a trust bank account

Note that individuals named personally as trustees in the deed require a witness to sign it. Companies assigned the role of trustee may sign in their corporate capacity without a witness, in accordance with section 127 of the Corporations Act 2001.

Types of trusts in Australia

The different legal structures for trusts in Australia include:

• Fixed trusts: Common in Australia, a fixed trust ensures the trustee pass on income or assets to the beneficiaries exactly as outlined with no discretionary decision-making.
• Discretionary trusts (Family trusts): This trust is popular for families and small businesses, as trustees have total control over how the trust is managed. The trustee may establish a trust for their family member(s), for tax planning purposes, or to control how and when beneficiaries receive payments and assets.
• Unit trusts: These trusts are often used for property investment and joint ventures. Beneficiaries own units in this trust, similar to owning shares in a company. These units can be bought and sold.
• Testamentary trusts: This trust is created through a person’s Will, and comes into effect after they pass away. Their Will sets the rules for a testamentary trust and its beneficiaries, such as age restrictions on access to its assets. These trusts can be contested in court.
• Hybrid trusts: A mix of fixed and discretionary trusts, the hybrid trust allows trustees certain rights to allocate and position assets. However, beneficiaries are also granted rights and entitlements within the trust’s deed, limiting the trustee’s discretion.
• Superannuation trusts: All Australian superannuation funds are managed through trusts. The deed outlines how the fund works, and ensures beneficiaries can access their retirement savings. These trusts are important in estate planning.
• Charitable trusts: Set up to support charities and non-profit causes. The appointed trustee must manage the trust to meet a specific charitable goal, and may receive tax benefits for doing so. Beneficiaries are typically philanthropic organisations or groups.
• Bare trusts: In this trust, there is just one trustee and one beneficiary who has full control. Bare trusts are common where the beneficiary wants to use a shareholder nominee to remain anonymous.

Ongoing obligations for trust account compliance

For compliant trust account management, you must:

• Manage trust ledger setup and ensure separation of trust ledgers from the business’s general accounting records
• Distribute income and manage assets according to the trust’s deed
• Maintain accurate records for each beneficiary of the trust
• Lodge annual trust tax returns with the Australian Taxation Office (ATO)
• Stay compliant with national and state-based trust laws

While traditional paper ledgers are considered acceptable forms of trust record-keeping, trust accounting software is considered a more reliable tool for law firms to manage trust accounts.

Three-way reconciliation: The cornerstone of trust accounting

Three-way reconciliation is a critical part of trust account compliance. It involves comparing and aligning three separate records:

• Trust account ledgers maintained by the law firm, detailing all transactions of the trust account
• Client ledgers for the trust account, which should match with the trust account ledgers
• Trust account bank statements, providing third-party confirmation of all transactions.

To do this, trustees must:

• Gather required records: Monthly bank statement, trust ledger and client trust ledger listing with balances for each beneficiary
• Reconcile the bank statement to the trust ledger to ensure they match, investigating any discrepancies
• Reconcile the trust ledger to client ledger listing, adding individual client balances and ensuring the total matches the trust ledger balance
• Confirm and document the reconciliation, ensuring the three key records match

Common errors and discrepancies in reconciliation

Common pitfalls of three-way reconciliation and trust accounting procedures include:

• Unrecorded transactions: Avoid losing sight of deposits and withdrawals by using automated alerts or daily transaction logs
• Misallocated funds: Check client references before posting funds, so they aren’t allocated to the wrong client ledger
• Timing differences: Use cutoff dates and take note of pending transactions to align ledgers with bank statements
• Math errors: Use trust accounting software to validate and automate calculations, minimising risk of errors and incorrect totals
• Failure to reconcile monthly: Non-compliance can result in penalties and compounding errors.

Frequency of three-way reconciliation

Trustees must carry out three-way reconciliation for each month across all states and territories.

The time allowed to complete this differs by state and territory; trustees must complete this process and provide statements:

• Within 5 business days at the end of the month in Queensland,
• Within 15 working days of month-end in Victoria, ACT, New South Wales, the Northern Territory, South Australia, Western Australia, Tasmania

Trust accounting software solutions for law firms

There are several options for trust accounting software in Australia. These packages can support firms and trustees to manage separate trust accounts and client ledgers, and ensure software trust account compliance.

It’s critical to consider approved legal trust accounting software that is secure and can:

• Comply with state regulations
• Timestamp transaction approvals and provide an audit trail
• Integrate with other trust and accounting tools for general ledger and financial reporting
• Provide flexibility with three-way reconciliation, trust ledger account management

Platforms such as LEAP, Smokeball, and ATOM are recommended by the New South Wales Law Society for their flexibility, easy integration with other tools like Xero.

To implement trust accounting software, assess your needs as a trustee or firm, prepare your data for input, and use vendor onboarding services to set up correctly and receive training. If migrating from another method, run parallel checks and monitor reconciliation to ensure a smooth transition.

Tax implications of trust account management

Income tax and GST are the core trust accounting tax implications in Australia.

Beneficiaries pay tax on net income if they are presently entitled to income from the trust. This includes capital gains if the trust sells assets. Trustees may pay this tax when income is retained in the trust.

GST may apply when a law firm issues tax invoices for services carried out as the trustee, or when a trustee is running a business through the trust.

Depending on the type of trust, other tax implications include:

• Fringe benefits tax can apply if the trust runs a business and offers fringe benefits to employees
• Payroll tax can apply if the trust employs staff and exceeds certain wages thresholds
• Stamp duty or land tax applies if the trust acquires property

Avoid common tax pitfalls by making timely trustee resolutions, characterising transactions accurately, and ensuring accurate streaming where necessary.

Cash flow management with trust accounts

Managing client money as a law firm can have significant impacts on cash flow. Even though the firm doesn’t own trust money, the timing of money movements can impact operations.

Trustees can forecast trust account cash flow and project working capital needs by:

• Recognising incoming funds, expected payments, and settlement timelines early
• Reconciling expected cash inflows and outflows regularly
• Establishing internal triggers or alerts when funds must be distributed
• Using ‘look-ahead’ models to predict future cash needs and avoid liquidity issues

Trust accounting software can also support firms by providing real-time monitoring of client balances, and using alerts to streamline cash flow visibility while staying compliant.

Compliance monitoring and reporting requirements

As a trustee, you must maintain and report accurate records of all trust account transactions, reconcile regularly, and ensure audit-ready documentation.

Trust accounts must comply with Australian auditing standards, and audits should be conducted by qualified, independent professionals.

In some sectors, the Australian Securities and Investments Commission (ASIC) requires annual trust account statements and audit reports to be lodged within strict timeframes. Law firms must also report to relevant professional bodies such as Law Societies.

For ongoing client money compliance:

• Ensure client money is separated from firm funds and accessed with proper authorisation
• Maintain transparent records and disclose how client funds are managed (including any interest earned)
• Implement internal controls and staff training to instil best practice
• Carry out internal reviews and periodic external audits to manage risks and confirm legal, regulatory, and professional standards are met

Common trust accounting challenges and solutions

Firms can face trust accounting challenges like misallocated client funds, delayed reconciliations, and poor audit trail documentation, leading to compliance breaches.

For comprehensive trust account management, consider:

• Using a specialised software to separate ledgers, automate reconciliation and reporting, and timestamp transaction approvals
• Seeking training on legal trust account best practices and risk mitigation
• Having reconciliations and bank statements peer-reviewed to catch errors

Law firms may also utilise digital workflows in practice management systems for extra consistency and audit-readiness, reducing chances of human error.

State-specific requirements across Australia

While principles for trust accounting in Australia are generally consistent nationwide, some state and territory regulations can vary by:

• Reconciliation process and frequency
• Audit requirements and frequency – some states require state-appointed auditors
• Approved financial institutions – some states mandate trust accounts be held at specific banks
• Definitions for different trust account types
• Set periods for client record retention
• Ledger balancing timeframes
• Relevant regulatory bodies – including state law society or legal boards
• Cross-jurisdictional compliance for firms operating across regions

Investigate the state trust accounting requirements relevant to your firm and review internal processes to ensure practices are aligned. This will enable you to mitigate risk and avoid costly penalties, and design workflows that support compliance.

Technology integration and automation opportunities

Modern trust accounting software offers law firms powerful automation and integration opportunities to manage compliance and improve efficiency:

• Automated reconciliation and alerts reduce errors and improve accuracy
• Practice management integration syncs trust account data, invoices, and client records
• Cloud-based platforms offer secure access, backups, and audit-ready logs
• Built-in safeguards like user permissions and encryption mitigate cyber risk

Legal technology solutions empower trustees to follow best practice and stay compliant.

Streamline your trust accounting with Xero

Xero offers a comprehensive and secure accounting platform tailored to law firm financial management with robust trust accounting features. It supports client ledger tracking, automated reconciliations, and separation of trust money from firm funds.

Seamless integration with legal practice management systems allows Xero users to import billing data directly, reducing administration and error rates.

With built-in audit trails, document storage, and configurable access controls, Xero helps firms uphold trust accounting best practices and audit-readiness.

FAQs on trust accounting for Australian law firms

How often must three-way reconciliations be performed?

Australian jurisdictions require monthly three-way reconciliation, though deadlines for each month differ across regions. Frequent reconciliation allows trustees to identify discrepancies and stay compliant.

Ensure your three-way reconciliation aligns the trust account’s bank balance, beneficiary ledgers, and internal records.

What happens if trust account compliance issues are discovered?

It’s important to respond quickly when issues are identified. Investigate the root cause, update records accurately, and notify regulators or legal boards if necessary.

Solutions include reviewing past reconciliations, tightening internal controls, providing training, or seeking external audits. Taking clear, transparent steps will demonstrate the firm’s integrity and commitment to upholding trust accounting standards.

Can trust accounting software integrate with existing practice management systems?

Yes, specialised accounting software offers integration with mainstream legal practice management systems. These connections enable client balances, billing details, and trust transactions to flow automatically between platforms and the delivery of real-time financial records. This cuts down on manual entry and reduces the risk of errors, improving workflow efficiency for legal staff.