Expense reimbursement refers to the practice of an organization paying back the expenses initially covered by employees. It’s actually required by law in some states, but the truth is that almost every organization should consider this process.
Whether you’re an academic institution, a municipal government, or a for-profit business, employee expense reimbursement is a regular part of your workflow. Major universities like NYU, Cornell, and Brown for example all have formal policies in place for this purpose.
Let’s talk about why this focus is important, and what you can do to introduce a mutually beneficial reimbursement plan to your organization.
What Is Employee Expense Reimbursement?
No matter the size or industry, a business must occasionally purchase goods, materials, and services to function. When employees have to pay out of pocket, business expense reimbursements ensure they get that money back fairly. This type of payment differs from usual salaries in that income taxation does not apply.
It’s sometimes more immediately convenient for an employee to pay certain expenses related to the job directly, and a formal reimbursement program ensures not only do staff receive a fair share back, but also management itself has more control over spending and takes advantage of maximum tax benefits.
Poorly implementing such a policy 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 Should You Care?
While reimbursing anything employees pay for on the company’s behalf 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, resulting in unnecessary taxation – not to mention employees frustratingly seeking proper reimbursement. 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.
What Costs Should Be Reimbursed?
We need a clear definition of “reimbursable expenses” before we can start talking about process optimization. Some common examples that many employers work with include:
- Business travel costs: This includes things like lodging, meals, and transportation. Remember to factor in costs like airport fees, travel documents, and (in these days) vaccination mandates. This category is common for employees on a business trip, even if they are using a personal vehicle.
- Communication: If you’re spending funds on employee travel expenses, it’s natural that reliable communication is a high priority. Mobile telephones and cellular network services are worth covering whenever employees travel.
- 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 event.
- Supplies and tools: This includes computers, mobile devices, and stationery that staff may buy with their own money.
- Retirement planning: Services that make up part of an overall retirement strategy from the organization.
- Tuition reimbursement: For corporate or college education that the business asks for.
Once an employee on payroll submits these 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. Define clearly 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 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.
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 reasonable time. 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 actually 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
While greatly beneficial to the companies that do it well, tracking reimbursed employee expenses is hardly a walk in the park for several reasons. Defining what counts as reimbursable is not a challenge for the employer, but a few potential difficulties involve:
- Employees being responsible for paying related expenses. A staff member may need pay out of pocket occasionally, which involves some financial decision-making on his own behalf.
- Employees must also report these transactions. The employee must also know the formal process for documenting such a transaction for analysis by the company later. Confusing purchasing policies from the business can exacerbate this problem.
- Management having 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 on 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 towards your specific needs. You might choose a fixed rate or adjust based on responsibilities of the staff members involved.
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 your 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.
Consult your state administrators over how reimbursements are legally handled in terms of Medicaid, Medicare, and health savings account (HSA) payments. You might have to file a claim through your doctor to get the process going.
Streamlining the Process With Automation Tools
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.
If you’ve ever heard of expense management tools, then you know the value of automation in fields like this. 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.
Expense reimbursement is money paid back to an employee or client as repayment. Examples of expense reimbursement include staff reimbursement for travel or business expenses, communication, food, etc.
Accurately tracking expense reimbursements is important and can benefit from using an automated solution. Implementing a formal process for documenting and managing expense reimbursements is key to keeping them accounted for and repaid.
Expense reimbursement is not considered income and is not taxable as income.