Expense Reimbursement Guide: Overview and FAQs

Expense reimbursement refers to the practice of paying back business expenses initially covered by employees. It’s required by law in some states, but the truth is, every organization should practice fair reimbursement for business-related expenses. It’s a means of streamlining the purchasing process, empowering employees, and speeding up the supply chain.

Whether you’re an academic institution, a municipal government, or a for-profit business, employee expense reimbursement is a regular part of effective expense management. Major universities like NYU, Cornell, and Brown for example all have formal policies in place for this purpose.

Let’s talk about why reimbursing out-of-pocket expenses is so important, and what you can do to introduce a mutually beneficial expense reimbursement policy to your organization.

What Is Expense Reimbursement?

No matter the size or industry, a business must occasionally purchase goods, materials, and services to function. When employees have to pay upfront, business expense reimbursements ensure they get that money back fairly. This type of payment differs from usual salaries in that tax deductions are not applicable.

It’s sometimes more immediately convenient for an employee to pay certain expenses related to the job directly. A formal expense reimbursement plan ensures staff receives a fair share back, management itself has more control over spending, and it’s easier to maximize tax benefits.

Without a smart plan in place, expense reimbursement requests, expense reports, and spending may go unnoticed, leading to an inability to pay people back within a reasonable period. In addition, a nonaccountable plan can be a source of frustration and friction for both sides. So, let’s discuss the importance of putting together a solid procedure for employee reimbursement.

Why are Expense Reimbursements Important for a Business?

It’s always important policy to pay people back. While reimbursing anything employees pay for makes sense, you might be wondering why you need a formal policy in place for expense reimbursement. An accountable plan grants you several advantages:

• Not everything you pay for ends up becoming taxable income.
• Employees are encouraged to make payments on time and keep the overall process moving.
• Both the staff and management will save themselves time and possible confusion.

Many companies don’t reimburse efficiently or completely. Others have no visibility into how they are going about the process; almost half of companies don’t know how much they are spending on expense reports for example.

Examples of Expense Reimbursement

We need a clear definition of “reimbursable expenses” before we can start talking about process optimization. Types of expenses business owners may encounter include:

• Business travel costs: Travel-related expenses include things like lodging, meals, airfare, and transportation. Remember to factor in costs like airport fees, and travel documents. This category is common for employees on a business trip, even if they are using a personal vehicle. Mileage reimbursement may also be applicable here, but only for trips and not typically for things like commuting.
• Communication: If you’re spending funds on employee travel expenses, it’s natural that reliable communication is a high priority. Mobile phones and cellular network services are worth covering whenever employees travel. This helps ensure the accuracy of expense report data and streamlines travel and expense management tasks.
• Insurance costs: The insurance industry often uses reimbursement as a way to allow policyholders to pay certain expenses out-of-pocket first and then cover anything that would be eligible under the insurance itself.
• Networking expenses: This last one can be tricky. We’ve covered food as a reimbursable expense, but what if an employee wants to bring a client to a fancy restaurant to foster a positive relationship? The resulting cost would be beneficial for the business to cover. The same idea also applies to entertainment services such as a concert or music events.
• Supplies and tools: This includes computers, mobile devices, and stationery that staff may buy with their own money.
• Retirement planning: Services that are part of an overall retirement strategy from the organization.
• Tuition reimbursement: For corporate or college education that elevates staff skill sets.

Once an employee on payroll submits expense receipts to the employer, the funds are usually sent by direct deposit to that worker’s account.

Because not everything counts as a business expense, not all employee purchases are eligible for this repayment. It’s important to be clear and transparent to your staff about what you consider reimbursable, especially for small businesses. Concisely define what you consider a transaction for personal reasons versus one for business purposes.

Deciding Which Business Expenses Are Eligible

The specific type of costs incurred that should be included in your program depends on your company’s unique circumstances. In general, such expenses need to be:

• Directly related to the workflow and required to get the job done.
• Have evidence of payment in the form of an invoice or other proof of payment. Such a document should contain the time and date of the purchase plus the exact amount of money spent.
• Reported to the employer, accounting department, or other necessary party in a reasonable time.

All these considerations are part of a broader expense reimbursement program that will empower your company and its employees to achieve fair compensation for meals, transportation, and other related expenses.

Tax Considerations

We’ve mentioned before that you can avoid purchases being considered taxable income when you seek reimbursement through an accountable plan, but there’s a lot more to consider in order to get the most out of these tax benefits.

Keep in mind that you can accidentally end up with taxable income if the employee fails to complete the payment initially within a reasonable time. This will make reimbursements taxable. Likewise, the IRS sets limitations on reimbursement funds and may require you to pay tax on any amount in excess. An example would be the business paying more for gas than the standard mileage rate would allow.

Another consideration is that certain reimbursable business expenses are still subject to taxation for the employees involved. Using a company car for non-business reasons is one example, as are certain professional services like legal advisory.

The takeaway here is that the key to maximizing tax benefits from employee reimbursements is to have a formal strategy and an accountable plan at the ready.

Challenges of Tracking Reimbursable Expenses

A business can run into challenges when tracking expenses. Here are a few examples:

• Employees are responsible for paying related expenses. A staff member may need to pay out of pocket occasionally, which involves some financial decision-making on their behalf. Employees may not be able to afford the expense at the time.
• Employees must also report these transactions. The employee must know the formal process for documenting such a transaction, or risk listing the wrong data. Confusing purchasing policies from the business can exacerbate this problem. Inaccurate data leads to issues with spend analysis and reporting later down the road.
• Management has to process reimbursement claims. Are the expense reports complete and accurate? Have you properly paid your employees on time?
• An inefficient reimbursement process. It should be obvious that this policy involves a lot of reporting, invoice collecting, and financial data entry, all of which are error-prone and time-consuming.

In other words, the traditional way most businesses approach expense reimbursement is often riddled with inefficiencies, frustration, and a large potential for mistakes. The solution here is to take a proactive approach by building a formal plan for structured cost reimbursement and adopting tools and technologies to make the entire process more seamless.

Building a Plan For Reimbursing Expenses

We’ve made references to an “accountable plan” earlier. Such an arrangement is not mandated by the IRS, but you should consider adopting one because of the accompanying benefits.

• An accountable plan covers all reimbursements paid to employee business expenses so that none of them end up subject to payroll taxes.
• It allows management to comply with IRS regulations regarding what is considered “reimbursable” and the nature of the deductible.
• The plan also prevents employees from experiencing taxation on what should be employer reimbursements.

Accountable plans additionally ensure that any reimbursements made are relevant to the business at hand. They require employees to accurately report spending activities and properly return excess amounts reimbursed to them.

The IRS specifically references accountable plans and specifies that nonaccountable payments are considered wages and subject to the appropriate taxation and other required actions.

Special Considerations and Miscellaneous Tips

Let’s end with a short list of best practices and miscellaneous considerations to factor in while designing your company’s ideal reimbursement program.

The Per Diem Rate

The travel expense is among the most common expenses incurred for reimbursement purposes. Because all the food, transportation, hotel rates, and other fees can be inconsistent and difficult to track, the employer often sets a daily allowance for each employee, known as the Per Diem rate.

The United States General Services Administration (GSA) sets a generic reimbursement rate depending on the location of your company, but you have the option to tailor the figure to your specific needs. You might choose a fixed rate or adjust based on the responsibilities of the staff members involved.

Fraud Prevention

Reimbursements can be a source of abuse, with a single incident costing the company $30,000 on average. Ensuring legitimacy in the process involves making sure payments aren’t exaggerated, which necessitates the use of an accurate expense report. You might need to establish internal controls to prevent fraudulent claims as well.

For example, specify a spending limit so that reimbursements don’t push you out of budget. Be clear about what type of spending on behalf of the company is acceptable. The aforementioned per diem rates are a common way to control daily spending.

Health-Based Reimbursements

Health-based and wellness reimbursements are also a consideration. Consult state administrators about how reimbursements are legally handled in terms of Medicaid, Medicare, and health savings account (HSA) payments. Employees may have to file a claim through a doctor to get the process going.

Streamlining the Process with Automation

Being such a data-heavy practice, employee expense reimbursement relies heavily on detailed and accurate documentation, as well as plenty of manual data entry. The result is an often error-prone process that takes up too much time, slowing down payments and frustrating everyone involved.

Expense management automation can handle all the most tedious parts of fulfilling reimbursements, such as data entry and communication.

• From the employee’s perspective, you only have to use a convenient mobile application to record all your receipts.
• For the employer, all you need is a dashboard to approve or deny claims quickly.
• The entire process takes seconds rather than hours.
• All documents, receipts, and messages are saved and organized automatically, cutting down on paperwork.

Employers have a legal and moral obligation to compensate employees for certain business expenses incurred during daily operations. Staying up to speed with your competitors involves having a reimbursement plan in place and empowering it with automation tools. Look for a system that offers a mobile app, automated expense reporting, streamlined approvals, and effortless ERP integrations.

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