What Is an Expense Reimbursement and How Does It Work?

An expense reimbursement involves an employer repaying an employee for costs incurred while conducting business activities. This practice ensures employees are not financially burdened when they spend their own money for company-related purposes and helps businesses cover legitimate operating costs.

Understanding Expense Reimbursement

Expense reimbursement is the process where an employer repays an employee for out-of-pocket expenses directly related to their work duties. This prevents employees from being financially disadvantaged for costs that ultimately benefit the employer, fostering fair compensation practices.

Common types of reimbursable expenses include travel costs like mileage, airfare, and lodging incurred during business trips. Meals and entertainment expenses are also frequently reimbursed, provided they have a clear business purpose. Other examples include purchases of office supplies, fees for professional development such as conferences or training programs, and client gifts.

The Reimbursement Process

Employees typically begin the reimbursement process by submitting an expense report. This report can be a physical form or submitted through an online portal or dedicated software, detailing the expenses incurred. The method of submission is usually outlined in the employer’s expense policy.

Crucial to the submission is proper documentation, which generally requires attaching receipts, invoices, or other proof of purchase. This substantiation verifies the expense and its amount. Without adequate documentation, reimbursement may not be possible.

Once submitted, the expense report usually undergoes an approval process. This often involves a direct manager reviewing the expenses for adherence to company policy and business purpose. Following manager approval, the finance department typically conducts a final review before processing the payment.

Reimbursement payments are commonly issued through direct deposit into the employee’s bank account or via a physical check. The timeframe for receiving reimbursement can vary, but most companies aim to process payments within a few business days to a few weeks, often within 10 to 30 days of approval.

Tax Considerations for Reimbursements

The tax treatment of expense reimbursements depends heavily on whether the employer’s plan qualifies as an “accountable plan” under IRS regulations. An accountable plan offers tax advantages because reimbursements made under it are generally not considered taxable income to the employee. This means they are not subject to income tax withholding or FICA taxes.

To qualify as an accountable plan, the arrangement must meet three specific IRS rules under Internal Revenue Code Section 62. First, expenses must have a business connection, meaning they were incurred while performing services as an employee. Second, the employee must adequately account for these expenses to the employer within a reasonable period, typically by submitting receipts and other documentation. Third, any excess reimbursement or allowance must be returned to the employer within a reasonable timeframe, often within 120 days of the advance or when the expenses are substantiated.

Conversely, if a reimbursement arrangement does not meet one or more of these three criteria, it is classified as a “non-accountable plan”. Under a non-accountable plan, reimbursements are treated as taxable wages to the employee. These amounts are then subject to income tax withholding and FICA taxes (Social Security and Medicare), just like regular salary.

Employer and Employee Responsibilities

Employers hold several responsibilities in managing expense reimbursements effectively. They must establish clear, written expense policies that outline what expenses are reimbursable, the documentation required, and the submission procedures. Employers are also responsible for ensuring timely reimbursement of approved expenses, typically within a few weeks of submission. Maintaining accurate records of all reimbursed expenses is also an employer duty, which is important for audit purposes and compliance with IRS accountable plan rules.

Employees also have specific duties to ensure a smooth reimbursement process. They must understand and adhere to the company’s established expense policy before incurring costs. Keeping detailed records and receipts for all business-related expenditures is crucial for substantiation. Employees are expected to submit their expense reports in a timely manner, generally within 30 to 60 days of incurring the expense, and provide accurate and complete information.