When you’re an agile startup, allowing your employees to expense items and ask for reimbursement can give you a level of flexibility that you probably need. But it can also add a layer of complexity that you probably don’t need. That’s especially true if you don’t have a clear expense and reimbursement policy in place.
The key here is to find that sweet spot. To be tax compliant and to avoid headaches, expenses need to be work-related and, at the same time, the reimbursement can’t in any way constitute income for the employee. To help your startup find that line and hold your ground there, we’ve got three expense and reimbursement policy best practices you can apply.
Set up an accountable plan
An accountable plan gives you a way to track employee expenses and your reimbursements to them while building in proof of both the expense and its necessity for work.
It’s important to get this established because if you don’t, your employee could suffer. The only way to ensure that reimbursement payments you make to them get excluded from their income is to make those expenses/reimbursements compliant with the accountable plan rules laid out by the IRS.
Specifically, those are:
- Business-related expenses: Your employee can’t expense something they simply want, and you shouldn’t reimburse it, at least if you don’t want that reimbursement to count in their gross income. In fact, the IRS rule specifically says that under an accountable plan, “The employer does not reimburse employees for personal expenses.” To qualify for reimbursement without adding to taxable income, the expense needs to have been incurred “while performing services as an employee.” Generally, this means business travel and meals.
- Adequate reporting: To count under an accountable plan, the expense needs to have a verifiable time, place, and amount. Unless the employee is getting a per diem (note that there are specific IRS rules here, too), they also need to provide a receipt, bill, invoices, etc. for each expense. Basically, the IRS wants to see proof of the expense from the employee’s side and accounting on your business’s side in the form of an expense report.
- Timely submittal: Under an accountable plan, your business needs to cover the cost of the expense relatively quickly. You can’t be reimbursing your employees months later for something they paid out-of-pocket. Your employees also can’t be waiting months to submit expenses. To streamline this, many startups issue company cards to staff that are likely to incur a lot of expenses, like salespeople who travel. If employees will be paying the expense themselves first and applying for reimbursement, make sure you set up a process in which those expenses are submitted, reviewed, and reimbursed regularly (e.g., monthly).
Note that if your employee has a business expense and you pay them in excess (e.g., they took a $30 Lyft and you issued a flat-rate rideshare payment of $50), that excess ($20, in this case) can be taxed as part of their gross income. This also applies if you give an employee an advance — say, for an upcoming business trip. If they don’t return the excess within 120 days, it can count towards their taxable income.
Establish documentation requirements
A solid expense and reimbursement policy largely comes down to recordkeeping. And, as we briefly mentioned before, that means expense reports.
Building an expense report template
Specifically, your expense report template should include:
- The date and time of the expense
- The location
- The amount
- The business purpose (this can be a form field where the employee types it in or a drop-down menu that lets them choose the appropriate category)
- A place to upload proof of the expense
As far as that proof goes, it could be:
- A receipt
- A bill
- A fulfilled invoice
- A canceled check
Basically, as long as you can clearly show the IRS that your employee incurred that expense while performing services for your company, you’re good.
Just as importantly, make a deadline for employees to submit expenses. They might not love it, but it’s a requirement to comply with the accountable plan reasonable time period piece. A lot of startups require employees to get expenses incurred in any given month submitted by the last day of the month.
Don’t stop there, though. You also want to close the loop by tracking when and how your employee gets reimbursed for that expense, whether that’s your company paying off their company card, issuing them a check, or including it in their next payroll run.
This can sound like a lot of work — and it is. Fortunately, software solutions can help. We recently explored Brex and Ramp, two companies that offer spend management automation tools that can take some of the legwork out of the process for both you and your employees.
Make everything clear in the relevant place(s)
Here’s the thing. Your accountable plan and your expense reports only work if your employees know what’s required and how to comply.
Lay out the process clearly in your employee handbook and/or your financial policies and procedures manual. It requires a little extra work on the front end, but building out a step-by-step guide can save you a lot of time and headache down the road.
You should make two things abundantly clear in your handbook/manual:
- What counts as a business expense. This varies from business to business and role to role. A meal might be a relevant business expense for a salesperson who takes a prospective client out, for example, but not necessarily for a developer. Talk with your company’s tax professional to get clarity on what does and doesn’t count as an accountable-plan compliant expense and clearly outline it in your employee handbook and/or financial policies and procedures manual.
- How to access and submit the expense report template. It shouldn’t be hard for your employees to submit an expense report when they need to do so. Link to the expense report form and tell them how to submit it/where to send it, or give specific directions about how to use the relevant software to submit the report.
It might feel like a lot of work to establish an expense and reimbursement policy at your startup, but it will pay off. Plus, we can help. To consult with our tax experts to ensure your policies are compliant with the IRS accountable plan rules, get in touch.