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Managing escrow funds doesn’t apply to every company. Mainly attorneys and realtors are under strict regulations about how they handle escrow funds for their clients. The rules for managing escrow funds are mandated by state law and the rules of your professional association. For example, all states require attorneys to maintain a separate bank account for escrow funds and professional associations put similar requirements on all those who collect funds from a third party on behalf of their clients.
Escrow funds (or trust funds) belong to your client but are collected from a third party on your client’s behalf. Securities, funds and other assets can be held in escrow. In business accounting, escrow funds are classified as liabilities. The escrow funds liability account is named “Funds Held In Trust.”
Tracking Escrow Funds
- Open a separate bank account for escrow funds and add it to your chart of accounts. You may also choose to open separate escrow bank accounts for each client. This may assist you in tracking individual client’s escrow funds more accurately.
- Create your escrow funds liability account named “Funds Held In Trust.” Again, you may elect to create separate liability accounts for each client.
- The total funds in the liability account must always equal the total of the funds in the escrow bank account (or the combined totals if you have created separate accounts for each client).
- A good rule of thumb: Every transaction, whether a deposit or a withdrawal, must be posted to the “Funds Held In Trust” liability account and must be linked the the particular client.
- When disbursing funds, make sure to write checks from the specific escrow bank account.
IRS Tip: Track hard costs (the real outlays for expense) and soft costs (internal overhead costs) separately. To create an appropriate audit trail, choose to write separate checks for reimbursed expenses, internal expenses, and fees.