How to Create an Effective Expense Reimbursement Policy

What is an expense reimbursement policy? 

An expense reimbursement policy (also sometimes called an employee reimbursement policy) is a set of rules and processes used to compensate your team for out-of-pocket business expenses. 

There are no federal regulations that require employee expense reimbursement, but as of June 2024, 11 states in the US have some kind of reimbursement policy requirement. These include: 

• California
• Illinois
• Iowa
• Massachusetts
• Minnesota
• Montana
• New Hampshire
• New York
• North Dakota
• Pennsylvania
• South Dakota

Washington D.C. and Seattle, Washington have local laws requiring employee reimbursement, so check your city and state regulations or talk to a financial advisor before sitting down to craft an expense policy. 

Required or not, many companies choose to pay employees for out-of-pocket expenses because it establishes goodwill and comes with tax advantages — reimbursing qualified business expenses makes them deductible on taxes.

Benefits of an employee reimbursement policy 

Both you and your team benefit when the process for out-of-pocket reimbursements is formalized. 

Benefits for businesses

Reduced administrative burden: Streamlining expense reporting saves your accounting team time and frees up your management to focus on more impactful tasks (instead of playing detective with employee expenses). 

Improved compliance: Tracking, categorizing, and correctly reporting business expenses can help with tax compliance and save you the headache of an audit. 

Better fiscal responsibility: You can deduct qualified business expenses on your organization's tax return but only if there’s sufficient documentation. Having a paper trail can help you reduce your tax liability and prevent employees from going overboard with expenses.

Benefits for employees 

Clear expectations: A good expense reimbursement policy provides employees with a set of steps to follow, which prevents time-wasting errors.

Fair compensation: Employees are more likely to receive the correct reimbursement amount when there are clear rules and spending limits in place.

‍Simplified reporting: No one wants to do more paperwork, so having an expense reimbursement policy can help your employees submit reports quickly.

How to create an expense reimbursement policy

From expense submission guidelines to the approval process, here’s how you can create a reimbursement policy for your business. 

Decide on eligible expenses

Which expenses you choose to reimburse will depend on your industry, the individual position of each employee, and your organization’s budget and preferences. Here are some common expenses included on expense reimbursement policies: 

• Mileage for work-related driving
• Business travel expenses (accommodations, meals, airfare, conference fees)
• Work supplies purchased out-of-pocket (tools needed to complete someone’s job duties)
• Training expenses (course or seminar fees that can help an employee advance their skills in a current or future position)

Note that only business expenses that are considered “ordinary and necessary” can be reimbursed tax-free and deducted on tax-returns. The IRS considers some expenses to be personal, including: 

• Commutes (drives to and from an employee’s home to a primary place of business)
• Expenses that fall outside of what’s common or “ordinary and necessary” for your industry. 

For example, the IRS may frown on reimbursing employees for audio editing software if they work as real estate agents, unless the business can prove that the software was helping employees achieve a specific task related to their job. You can still reimburse employees for these expenses if you want, but you’ll need to treat the reimbursement amounts as taxed income and won’t be able to deduct it as a business expense. 

Use this guide from the IRS before making the final call on reimbursable expenses.

Set spending limits 

You probably don’t want to give employees a blank check on expenses — that could put a dent in your budget and raise eyebrows for auditors. For that reason, setting spending limits for certain purchases and making them clear in your expense reimbursement policy is important. 

Do your homework on reimbursable expenses in an employee’s area (fuel, accommodations, meals, etc.) to decide what’s fair. For mileage reimbursement, compensating employees below or at the IRS standard mileage rate ($0.67 in 2024) allows you to keep reimbursements tax-free.

You can also use the per-diem reimbursement rates set by the federal government as a guide. 

Documentation requirements

Next, you’ll need to decide on documentation requirements for reimbursement. In other words, what do you need from employees in order to determine if an expense is eligible? 

Many businesses use an expense sheet that asks employees for details like:

• Date of purchase
• Description of the expense
• Total amount paid (cost incurred)
• Vendor information, if applicable

Requiring employees to attach receipts is also a good idea, since it will give you a way to verify purchases made.

Of course, this method doesn’t work for all types of employee expenses. If reimbursing mileage, you’ll need to request that employees submit mileage reports. Thankfully, using a mileage tracking app, like MileIQ, can automate this process by tracking and generating reports without extra work for your team.

Create an expense report process 

Once you have your list of expenses, spending limits, and ways to qualify them, time to work out instructions for your team. You’ll need to include these in your expense reimbursement policy so your organization has a clear set of steps to follow. 

Accountable vs. nonaccountable plans

You can choose to create an accountable on a non-accountable expense reimbursement plan. An accountable reimbursement plan comes with strict guidelines: An employee needs to submit their expenses for reimbursement within a certain period of time, and if over-reimbursed they need to return the amount within a certain time period. 

This approach comes with some extra administrative tasks, but it’s much better at capturing all expenses accurately and may help with compliance, since all record-keeping is regulated.

Non-accountable plans often focus on per diem allowances — employees don’t need to provide receipts or submit expenses but their reimbursement amounts are treated as taxable income. This type of expense reimbursement policy is easier to administer but doesn’t offer the same tax benefits. 

Approval process

Lastly, you’ll want to create a process for approving expenses. For instance, you may ask team leaders to review expenses of direct reports and then pass on to accounting, or have employees send reports to accounting who will verify the expense with managers. 

Here at MileIQ our business clients can approve mileage reports from one dashboard with much of the information already verified and in place, like routes, mileage, and reimbursement calculations.

Key takeaways and tips: Expense reimbursement policies 

• Update your reimbursement policy often: As your business changes so do the kinds of expenses employees may incur — it’s also a good idea to stay up to date with latest regulations around expense reimbursement.  
• Communicate with your team: Employees won’t follow an expense policy if they don’t know it exists. Make reviewing the policy a part of your onboarding process and notify everyone about any upcoming changes. 
• Make your life easier with automation tools: Reimbursing employees, especially for something less tangible, like mileage driven for work can be painful. Using a tool like a mileage tracking app or an expense tracking software can make following the rules in your policy easier for you and your team. 

If your employees drive for work, MileIQ can help you track mileage, calculate reimbursements based on an-IRS compliant rate, and manage approvals. It’s a must-have tool for anyone who drives for work or manages drivers!