- Employers may be required to cover reasonably necessary employee expenses incurred for work-related purposes.
- Expenses eligible for reimbursement and tax deduction are defined under the U.S. Internal Revenue Service (IRS) Publication 463.
- Establishing an expense reimbursement policy is key to controlling costs, tracking expenses and developing an efficient internal process.
- This article is for employers who want to understand their expense reimbursement obligations under the law and establish an employee expense reimbursement policy.
When an employee incurs expenses on behalf of your business, how should they be reimbursed and what qualifies as a reimbursable expense? While there are legal minimum requirements to meet, in some cases it might make sense to go above and beyond. This guide examines what you need to know to develop an effective and fair employee reimbursement policy.
What is expense reimbursement?
Expense reimbursement occurs whenever an employee incurs costs required to complete their job on behalf of a business and the employer covers those costs. For instance, for business travel, this can include stays at hotels, meals, mileage and vehicle costs, or flights.
"Employees shouldn't be negatively impacted when they use personal assets for the company," said Rob Stephens, founder of CFO Perspective.
Beyond a moral and ethical consideration, though, employee expense reimbursement is also a legal consideration.
"Broadly speaking, when you think about having to reimburse employees for expenses there are federal and state laws," said Danielle Lackey, chief legal counsel at Motus. "Federal is tied to minimum wage. In any state, if you have someone making at or close to minimum wage at a business of any size … your business is going to want to pay really close attention."
The federal requirements for expense reimbursement require employers to ensure that any expenses incurred by an employee do not bring their take home pay below the cost of minimum wage, calculated as the net amount an employee collects after any costs they incur that are necessary for business.
Failure to reimburse employees adequately can open up your business to lawsuits and financial penalties under the federal Fair Labor Standards Act (FLSA). However, many states have requirements beyond this federal obligation, Lackey said.
"The federal level is the bare minimum. At the state level, there are specific states with more stringent reimbursement laws," Lackey said. "These are not tethered to minimum wage; employees are reimbursed for any expense reasonably necessary to do their job."
California and Illinois are two states with such a reimbursement law. To determine your reimbursement obligations in your state, consult legal counsel to ensure your reimbursement policy meets legal requirements.
Key takeaway: Federal law requires employers to reimburse employee expenses to maintain a take-home pay above minimum wage, but some states go further. Confer with legal counsel to determine your obligations.
What types of expenses should be reimbursed?
There are several types of expenses that employees might reasonably incur while performing their duties, especially if those duties involve travel or landing sales.
"A lot of times it is easier for an employee to pay for something than the employer," Stephens said. "They may use a credit card to sign up for a class or to pay for airfare or a hotel. It's really more of a convenience for the employee to pay directly for the expense."
When this happens, of course, employees should be reimbursed. In many cases, it might even be legally required. Luckily, many types of business expenses that employers reimburse are considered tax-deductible.
Reimbursement eligible expenses are defined under the U.S. Internal Revenue Service (IRS) Publication 463, which lays out the criteria needed for expenses to be considered reimbursable and tax-deductible. The major expenses outlined by the IRS include:
- Transportation: Employees should be reimbursed for airfare, train or other transportation costs related to business. For example, if an employee is required to travel for a business meeting, the cost of any transportation to, from, and during the business-related event should be considered eligible for reimbursement.
- Mileage and vehicle: Mileage and vehicle costs are reimbursable under the IRS guidelines at a rate of $0.575 per mile. This rate describes the standard deduction available to employers rather than the true cost of mileage reimbursement. For more information on how to identify an optimal rate and develop a policy, read Business News Daily's guide to mileage reimbursement.
- Accommodations: Any accommodations an employee requires during a business-related trip, such as hotel costs, are considered reimbursable expenses. Some employers may opt to offer a per diem rather than require an employee to submit receipts.
- Meals: Meals can also be considered reimbursable business expenses. However, it is a good policy to set a reasonable limit on the meal expenses that will be reimbursed, as some employees might be tempted to have a lavish surf and turf meal at a Michelin star restaurant when tavern fare will do. Again, a per diem could be offered instead of requiring employees to submit receipts.
- Gifts: Gifts for employees or business partners can be deducted up to $25 per person per year. If an employee purchases a gift for a client on your company's behalf, it should be reimbursed.
It is worth noting that entertainment costs were previously considered tax-deductible under the law, but were removed under the Trump Administration's 2017 tax law, known as the Tax Cuts and Jobs Act. However, if an employee covers entertainment expenses in trying to land a sale or during negotiations with a supplier, you should still consider reimbursing them for the money they laid out.
The above expenses are not necessarily required to be reimbursed under federal law but are considered tax-deductible, if they meet the criteria laid out by the IRS. To learn more about tax deduction criteria used by the IRS, read the agency's guidelines on reimbursable business expenses.
Key takeaway: Many reimbursable expenses are also tax-deductible. Understand what these are so you can maximize your tax benefit related to employee expenses.
How to manage expense reimbursement
If you are in need of an expense reimbursement policy, follow these five steps to ensure you have both a fair and compliant reimbursement plan in place:
1. Identify reimbursable expenses.
Make a list of the reimbursable expenses that your employees are likely to incur. Clearly identify which expenses are considered reimbursable under your policy. Remember that expense reimbursement should always apply if any reasonably necessary business expenses would result in an employee's take-home pay falling under the minimum wage.
2. Set limits.
To prevent unscrupulous employees from overspending or taking willful advantage of your reimbursement policies, set clear limits on expenses. You can do this by implementing maximum expenditures for specific items in your policy, or by instituting a per diem when employees are traveling on behalf of the company. Regardless, it is important to set limits to avoid being taken advantage of.
"Another thing you have to consider in your policy is … whether you want to put guidelines or maximums on [expenses]," Stephens said. "Some people, absent guidelines, go big on the company's dime."
3. Develop a process.
Clearly articulate an internal process for approving expenses and reimbursing them. Employees should understand how to submit receipts and whether they should do so through software. It should also be clear who is responsible for approving expense reports; in a manual system, employees will submit receipts to this individual, while software can directly route receipts to them for approval. Finally, make it clear when and how reimbursement will be delivered to the employee. Many businesses will add the total to an employee's next check. Others might cut a separate check at the time of expense approval.
4. Track expenses.
Naturally, you should closely monitor employee expenses and ensure they are valid and within the parameters of the guidelines and limits you've established. Software can help you track expenses as well. Some accounting solutions like QuickBooks and Xero have companion apps for expense tracking and stand-alone solutions like Concur or Expensify can automate receipt delivery and tracking. [Read related article: The Best Receipt-Tracking Tools for Professionals]
5. Communicate your policy clearly.
Let your employees know about your policy before they incur reimbursable expenses. If necessary, call a meeting to explain the policy to them in detail. Leave no room for misinterpretation; describe what qualifies as a reimbursable expense and what doesn't. Also, be sure you clearly articulate any guidelines, limits or exceptions you built into your policy.
Reimbursing employees for business expenses is important both for legal compliance and employee morale and retention. Companies are often expected to reimburse employees for any expenses they incur on behalf of the business, but that doesn't mean you need to promise them an all-expenses-paid trip to the Ritz Carlton. Developing a fair, detailed employee expense reimbursement plan can help you strike the right balance, keeping you compliant, your employees happy and your bottom line intact.
Key takeaway: When developing your reimbursement policy, consider software tools that can help you track expenses and document employee expenditures.