Navigating expense reimbursements can feel like walking a tightrope. You want to compensate your employees fairly for business-related costs, but you also need to ensure your process aligns with IRS regulations to avoid tax headaches. Getting it right means keeping your employees happy and your company compliant.
This guide will walk you through the essentials of creating and managing an IRS-compliant expense reimbursement policy, leveraging insights directly from IRS guidelines.
What is Expense Reimbursement?
Expense reimbursement is the process by which a company pays back employees who have spent their own money for business-related purposes. This could range from travel and meals to software subscriptions or office supplies purchased for work.
The key is that these expenses are incurred in the course of performing job duties.
What is an Expense Reimbursement Policy?
An Expense Reimbursement Policy is a formal document created by a company that outlines the specific rules, procedures, and guidelines for employees seeking reimbursement for business-related expenses they have paid for out-of-pocket.
It defines which expenses are eligible for reimbursement, specifies spending limits (if any), details the required documentation (like receipts), explains the process for submitting expense reports, and outlines the timeline for repayment.
Essentially, it's the company's rulebook for handling employee expenses fairly and consistently.
Why do Businesses Need an Expense Reimbursement Policy?
Having a clear and well-communicated Expense Reimbursement Policy isn't just bureaucratic box-ticking; it's essential for several key reasons:
- Ensures IRS compliance: As detailed throughout this guide, a well-structured policy, particularly one designed as an "accountable plan," is crucial for ensuring reimbursements are treated correctly for tax purposes (non-taxable to employees, deductible for the business). It helps meet IRS requirements for substantiation and record-keeping.
- Provides clarity and fairness: A formal policy eliminates guesswork for employees. It clearly sets expectations about what the company will pay for, the amount, and what proof is required. This promotes fairness and consistency in how expense reimbursements are handled across the organization.
- Facilitates budgeting and cost control: By defining allowable expenses and potential spending limits, the policy helps businesses predict, manage, and control operational costs associated with employee spending.
- Prevents errors and reduces fraud: Clear guidelines and required documentation minimize unintentional errors in expense reporting. A formal process with checks and balances also acts as a deterrent against fraudulent claims.
- Increases operational efficiency: When everyone understands the process – how to submit claims, what documentation is needed, and who approves them – it streamlines the entire reimbursement workflow, saving time for both employees and the finance/HR teams processing the claims.
What are Some Reimbursable Expenses?
Generally, reimbursable expenses should cover the necessary costs that employees incur that are directly related to their work. Common examples include:
- Travel costs (airfare, lodging, car rentals)
- Business meals
- Client entertainment (subject to specific IRS limitations)
- Transportation costs (mileage, taxis, public transport)
- Supplies and materials
- Professional development and training fees
The specifics often depend on the company's policy, but the underlying principle for IRS purposes is the business connection.
What is an Accountable Expense Reimbursement plan?
This is a critical concept defined by the IRS. An accountable plan is a set of rules for handling expense reimbursements that, if followed, allows reimbursements to be excluded from employees' taxable income. It's the gold standard for reimbursement policies.
The Three Pillars of an Accountable Plan
For a plan to be considered "accountable" by the IRS, it must meet three specific requirements, as outlined in regulations like § 1.62-2 and confirmed in guidance such as Revenue Ruling 2003-106:
- Business Connection: Expenses must have a clear business purpose. Personal expenses cannot be reimbursed under an accountable plan.
- Substantiation: Employees must adequately account for their expenses within a reasonable period. This means providing proof of the expense (amount, time, place, business purpose). (IRS, Rev. Rul. 2003-106)
- Return of Excess Funds: Employees must return any reimbursement amount exceeding the substantiated business expenses within a reasonable period.
Why an Accountable Plan Matters for Tax Purposes
The primary benefit of an accountable plan is its favorable tax treatment. Reimbursements made under an accountable plan are generally:
- Not considered taxable income for the employee.
- Deductible by the employer as a business expense.
This is the most tax-advantageous way to handle reimbursements for both parties.
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Understanding Non-Accountable Plans and Tax Implications
Under a non-accountable plan, all reimbursements or advances are treated as taxable wages paid to the employee (IRS, § 1.62-2). This means:
- The reimbursement amount is added to the employee's gross income.
- The amount is subject to income tax withholding, FICA (Social Security and Medicare), and FUTA (federal unemployment tax).
- The employer can still deduct the expense, but it's treated as compensation paid, not a direct reimbursement of a specific business expense under the accountable plan rules.
Common reasons a plan might become non-accountable include failing to require substantiation or allowing employees to keep excess advances.
For more information, please refer to IRS 26 CFR 1.62-2: Reimbursements and other expense allowance arrangements.
What Are Non-Taxable Reimbursements In An Expense Reimbursement Policy?
Non-taxable reimbursements are those made under a properly implemented accountable plan.
How Accountable Plans Ensure Non-Taxable Reimbursements
By strictly adhering to the business connection, substantiation, and return of excess funds rules, the employer ensures that the reimbursements directly offset legitimate business expenses incurred by the employee.
The IRS views this as the company essentially paying its own expenses via the employee, rather than providing additional income to the employee.
Therefore, these reimbursements are excluded from the employee's wages under § 62(a)(2)(A) of the Internal Revenue Code.
What Are Deductible Expenses In An Expense Reimbursement Policy?
For an expense to be deductible by the business (and reimbursable non-taxably to the employee under an accountable plan), it must generally be considered an "ordinary and necessary" business expense according to IRS rules.
An ordinary expense is one common and accepted in your trade or business; a necessary expense is one that is helpful and appropriate. This ties directly back to the crucial "business connection" requirement of accountable plans.
Here are some common categories of expenses that are often deductible if they meet the criteria and are substantiated correctly under an accountable plan:
- Business travel: Costs associated with travel away from your tax home for business purposes, including airfare, lodging, car rentals, taxis, and baggage fees.
- Business meals: Costs of meals while traveling for business or meals with clients/colleagues for a specific business purpose (often subject to a 50% deductibility limit for the business, check current IRS Publication 463).
- Business use of car: Expenses related to using your personal vehicle for business. You can typically use either the standard mileage rate set by the IRS or track actual expenses (fuel, oil, repairs, insurance, registration – prorated for business use). Commuting costs are generally not deductible.
- Supplies: Office supplies (pens, paper, ink) and other materials necessary for conducting business.
- Tools & equipment: Costs of tools or equipment used for work, particularly if they wear out within a year (longer-lasting items may require depreciation).
- Professional development & education: Costs for work-related education, training, workshops, webinars, or industry conferences that maintain or improve skills required for your current job.
- Dues and subscriptions: Fees for professional organizations, trade associations, and subscriptions to industry-specific journals relevant to your work.
- Business use of phone/internet: The portion of your personal cell phone or home internet bill attributable to business use.
- Home office expenses: If you use part of your home exclusively and regularly for business (and meet specific IRS criteria, especially relevant for remote employees), a portion of rent, mortgage interest, utilities, and insurance may be deductible/reimbursable. Rules can be complex; see IRS Publication 587.
- Business gifts: Gifts given to clients or business associates (deduction typically limited to $25 per person per year).
Important Note: Always ensure expenses align with your company's specific reimbursement policy and IRS guidelines. The deductibility of certain items (like meals or home office use) has specific rules and potential limitations.
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The Law And Your Expense Reimbursement Policy
Your policy isn't just an internal document; it's governed by tax law, primarily the Internal Revenue Code and associated regulations.
IRS Rules: The Foundation of Your Policy
The core IRS rules revolve around the accountable plan framework (§ 62(c), § 1.62-2), substantiation requirements (§ 274(d)), and record-keeping guidelines.
Building your policy on these foundations is crucial for compliance.
Substantiation: Proving Business Expenses to the IRS
Substantiation is how employees prove their expenses meet the business connection requirement. It’s non-negotiable for an accountable plan.
What Constitutes Adequate Substantiation?
Employees generally need to document:
- Amount: The cost of the expense.
- Time: The date the expense was incurred.
- Place: The location where the expense occurred (e.g., city, name of restaurant).
- Business Purpose: The reason for the expense and its connection to the business.
- Business Relationship (for meals/entertainment): Names and roles of individuals involved.
Documentary Evidence: When are Receipts Required?
Generally, documentary evidence like receipts, paid bills, or invoices are required to support lodging expenses (regardless of cost) and any other expense of $75 or more.
However, your company policy can always require receipts for all expenses, which is often simpler to manage and provides a clearer audit trail. (Note: The $75 threshold is a common IRS guideline, but it's wise to always check current IRS Publication 463, Travel, Gift, and Car Expenses, for the latest figures).
The provided IRS documents emphasize the need for supporting documents like receipts, though they don't specify this exact threshold.
Handling Electronic Receipts and Reports (IRS Guidance)
The IRS explicitly permits the use of electronic systems for submitting expense reports and storing electronic receipts.
Revenue Ruling 2003-106 confirms that an arrangement using electronic receipts and reports can meet the accountable plan requirements, provided the electronic system effectively documents the required substantiation elements (amount, time, place, business purpose).
So, embracing digital solutions is perfectly compliant. (IRS, Rev. Rul. 2003-106)
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Record-Keeping Requirements for Businesses
Beyond employee substantiation, the business has important record-keeping obligations.
What Types of Records Must Be Kept?
Your recordkeeping system must clearly show income and expenses. Supporting documents are vital and include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks or other proof of payment (like bank/credit card statements).
These documents contain the essential information to verify expenses and should be readily accessible.
For more information, please refer to IRS Publication: What kind of records should I keep
How Long Must Expense Records Be Kept? (IRS Retention Periods)
You must keep records that support items on your tax return until the period of limitations for that return runs out. Generally:
- Keep records for 3 years from the date you filed your original return or the due date, whichever is later.
- Keep records for 6 years if you significantly underreport income (by more than 25%).
- Keep records related to employment taxes for at least 4 years after the tax becomes due or is paid.
- Keep records relating to property (assets) until the period of limitations expires for the year you dispose of the property (to calculate depreciation, gain/loss, etc.). Always check for specific circumstances or other requirements (e.g., from insurance companies or creditors) that might necessitate longer retention.
For more information, please refer to IRS Publication: How long should I keep records?
Types of Business Expenses in an Expense Reimbursement Policy
While your specific policy will define the details, understanding IRS expectations for common expense categories is helpful for ensuring compliance.
- Travel: Requires proof of cost for transportation and lodging, dates of departure/return, number of days spent on business, destination, and the business reason for the trip.
- Meals: Requires proof of cost, the date and location of the meal, its business purpose, and the business relationship of the persons involved. (Note: Deductibility rules for meals can change periodically; always consult the current IRS Publication 463).
- Gifts: Requires proof of cost, the date of the gift, a description of it, the business reason for giving it, and the business relationship of the recipient. (Be aware of annual deduction limits per recipient).
- Transportation: Requires proof of cost (or detailed mileage logs if using the standard IRS mileage rate), the dates of travel, your destination, and the business purpose of the trip.
Maintaining clear, specific records as described by the IRS for each type of expense is absolutely key for proper substantiation under an accountable plan.
How to Create an Expense Reimbursement Policy?
A strong, clear policy provides essential guidance for employees and ensures compliance for the business. Think of it as a roadmap for smooth and compliant expense handling.
Key Elements to Include for IRS Compliance
Based on the IRS guidelines discussed, your policy should clearly define these crucial elements:
- Business purpose: Clearly state what constitutes a valid, reimbursable business expense.
- Covered expenses: List the types of expenses eligible for reimbursement.
- Non-reimbursable expenses: Explicitly state what the company will not pay for.
- Spending limits: Define any caps or limitations on specific expense categories (e.g., daily meal per diems).
- Substantiation requirements: Detail exactly what proof is needed (receipts, invoices, explanations) and emphasize the need for documenting amount, time, place, and business purpose. Specify deadlines for submitting reports.
- Use of company cards (if applicable): Outline the rules and responsibilities for using business credit cards.
- Process for submission: Explain the step-by-step process for how and when employees should submit their expense reports (e.g., through specific software, email, etc.).
- Requirement to return excess advances: Clearly state that any advance amount not covered by substantiated expenses must be returned promptly.
- Consequences of non-compliance: Explain the potential tax implications (treatment as wages) if policy rules are not followed.
- Approval workflow: Outline who needs to review and approve expense reports.
- Reimbursement timeline: Set expectations for when employees can expect to receive their reimbursements after submitting a compliant report.
Steps to Develop and Implement Your Policy
Creating a policy involves more than just listing rules. Here’s a practical approach:
- Research and assess needs: Review the IRS guidelines, understand your company's specific spending patterns, common expense types, and any existing pain points in your current process (or lack thereof). Consider your company culture and size.
- Draft the policy: Start writing, using the key elements above as your checklist. Be clear, concise, and use straightforward language. Avoid jargon where possible. Ensure it addresses the three pillars of an accountable plan (business connection, substantiation, return of excess).
- Involve stakeholders: Share the draft with key departments like Finance, HR, Legal, and potentially managers who frequently approve expenses. Gather their feedback to ensure the policy is practical, compliant, and enforceable.
- Refine and finalize: Incorporate the feedback received and polish the language. Ensure consistency throughout the document.
- Obtain formal approval: Get the necessary sign-off from senior management or designated authorities within your company.
- Communicate clearly: Roll out the policy to all employees. Don't just send an email; consider a brief training session or Q&A to explain the key aspects, especially substantiation rules and submission procedures. Make the policy easily accessible.
- Implement and train: Ensure any tools or processes mentioned in the policy (like expense management software) are ready and users are trained on how to use them correctly.
- Review and update regularly: An expense policy isn't static. Review it periodically (e.g., annually) or when significant changes occur (like new IRS guidance or changes in business operations) to ensure it remains relevant and compliant.
Making IRS Compliance Easier: How Fyle Helps
Meeting all the IRS requirements for an accountable plan – detailed substantiation, timely reporting, accurate record-keeping, and proper approvals – can be manually intensive and prone to frustrating errors.
This is where modern technology steps in to make life easier.
Fyle empowers businesses to automate their entire expense reimbursement process, making compliance significantly less burdensome:
Real-Time Expense Capture
Employees can capture receipts instantly using different ways. You can simply text a picture of the receipt to Fyle, use the Fyle mobile app, use Gmail or Outlook, or even track them via Slack. This minimizes lost receipts and submission delays.
Fyle automatically extracts key data like amount, date, and merchant, simplifying the substantiation process right from the start.
Automated Policy Checks
Configure your specific expense policy rules directly within Fyle.
Potential violations like missing receipts, duplicate expenses, or spending over limits are automatically flagged before reports are even submitted.
This drastically reduces errors and helps enforce compliance with both your internal rules and IRS guidelines.
Digital Record-Keeping
All submitted expenses and their corresponding receipts are stored securely and centrally in the cloud. This creates an easily searchable digital archive that meets IRS record retention requirements and makes audits far less painful.
Say goodbye to digging through paper stacks!
Streamlined Approvals
Automated workflows intelligently route expense reports to the designated approvers, significantly speeding up the review and reimbursement cycle.
Approvers can approve employee expense reports right from Gmail, Outlook, Slack or the Fyle app while they are on the go - no more delays.
Seamless Accounting Integration
Fyle integrates smoothly with major accounting software like QuickBooks (Online & Desktop), NetSuite, Xero, and Sage Intacct. This ensures accurate and efficient data transfer for your bookkeeping and tax reporting needs.
Conclusion
By automating the often tedious aspects of expense management, Fyle helps you confidently maintain an IRS-compliant accountable plan, keep your employees happy with faster reimbursements, and free up your valuable finance team to focus on more strategic initiatives.
Schedule a demo today and discover how Fyle can revolutionize your expense reimbursement process.
Disclaimer: This blog post provides general information based on IRS guidelines referenced in the provided documents and common practices. Tax laws and regulations are complex and can change. It's always best to consult with a qualified tax professional for advice tailored to your specific business situation.
