In another post, we talked about how to handle missing receipts. While receipts should be collected for all expenses, receipts are particularly important for substantiating reimbursements to employees and third parties. With more nonprofits hiring remotely and turning to a work-from-home model, employee reimbursements for organization expenses are becoming commonplace. Although all operational policies should be written out, expense reimbursement policies for nonprofits are a must due to the scrutiny that these exempt organizations inherently face. In this article, we’ll walk through the considerations for creating your nonprofit organization’s reimbursement policy.

What are the types of reimbursement policies?

There are three types of employee reimbursement policies, though I would argue that the third method is not a “reimbursement” method at all. These policy types are:

  1. An Accountability Plan – a plan which requires employees to provide “accountability” – i.e. documentation – to support each expense before it is reimbursed to them.
  2. Also called an “Accountable Plan,” so we may use these terms interchangeably.
  3. A Nonaccountability Plan – a plan which does not require employees to provide documentation for reimbursements, only that reimbursement requests be submitted.
  4. A per diem plan, where a standard rate per mile/day/meal is paid after the fact, usually falls into this category.
  5. A Non-reimbursement Plan – an allowance, typically a flat rate, or an “advance” paid to the employee with the expectation that the employee uses those funds towards the employer’s benefit. Often this is a flat amount included in the employee’s regular paycheck, regardless of travel or expenses incurred on the employer’s behalf.

I say “employer’s benefit” rather than “organization’s benefit” because a non-reimbursable plan is not an acceptable method for a nonprofit organization to use for reimbursement; neither is a nonaccountability plan. Nonprofit organizations should not use nonaccountability plans or non-reimbursement plans because:

  • The amounts paid to employees under these types of plans are completely taxable and are reported in Box 1 of the W-2. This means that the employer – the nonprofit – has a higher payroll tax liability.
  • No documentation is collected under these plans, so the organization has no support for those expenses. This can cause problems not only with the IRS if they come under audit, but with their grantors if and where grantors require support for the funds spent. Lack of support on an egregious scale can cause the IRS to revoke a nonprofit’s exempt status, and cause funders to stop providing funds – or worse – enter proceedings to claw back funds already paid to the organization.

Since the other two options are arguably bad ideas for nonprofits, let’s focus on accountability plans.

Why should we use an accountability plan?

You already know that nonprofit organizations undergo more scrutiny than your average business. This extends from Board members doing routine reviews, donors checking out how their contributions have been used, and the IRS and other funders and nonprofit organizations inspecting the expenses on Form 990. As a result, nonprofit organizations are advised (strongly, really strongly advised) to collect and retain documentation for all expenses in some shape or form, to support audits conducted by the IRS or independent audits as required by internal or third parties. (Read this to find out how a nonprofit can prepare for an audit.) Reimbursements present a particular challenge because someone other than the AP department (who presumably already has documentation collection and retainage procedures in place) is incurring expenditures which will end up on the organization’s books. To protect the organization from missing documentation and questionable expenses, implement an accountable plan reimbursement policy. Going forward, we’ll simply refer to this as a reimbursement policy.

A Word on Per Diem

“Per diem” refers to an amount paid to an employee to cover lodging, meals, and incidental expenses incurred while working for the organization. Per diem reimbursements do not require that specific receipts be provided. A per diem reimbursement is often preferred by employees because if they manage to spend less than the per diem amount, they can keep the remaining amount. However, there are three scenarios to keep in mind when using per diem rates:

  1. Per diem rates with support – If you require that a per diem reimbursement request identify the per diem units (for example: miles traveled or nights in hotel lodging), you can include your per diem reimbursements as valid under an accountability plan.
  2. Per diem rates without support – if you do NOT require that a per diem reimbursement identify the units per diem to be reimbursed, the plan is more likely to fall under the non-accountability plan because you’re paying the reimbursement whether or not the reimbursement is used. This is akin to providing a work-from-home allowance that is provided as a pre-paid flat rate and is paid to the employee whether or not they use the funds for their work-from-home office and/or business use.
  3. Per diem rates exceeding the approved federal rates – setting a per diem rate that exceeds the federal per diem rate for that year creates a tax liability, where the portion that exceeds the federal rate is considered taxable income. When setting expense reimbursement policies for nonprofits, we recommend identifying the per diem rate as the federal per diem rate, to reduce annual updates when the federal rate changes.

Properly implementing a per diem rate in your nonprofit’s reimbursement policy is certainly acceptable, just be careful about how you use it and what you set as the minimum standard of documentation. Using a per diem rate does minimize the documentation required but does not completely eliminate it. Feel free to get in touch if you want to talk through this or have specific questions.

Elements of Reimbursement Policies for Nonprofits

Reimbursement policies for nonprofits should require that expense documentation specify certain elements before the expense can be reimbursed. We recommend specifying:

  • the purpose of the expense – the purpose of the expense should clearly be in line with the organization’s mission, or support of the organization itself. Expenses that do not support organization’s mission or provide support to the organization’s operations are unrelated business expenses, which often indicate that there are unrelated business activities, which may produce unrelated business income. Of course, unrelated business income is reported on the organization’s 990, and if over the $1,000 threshold, necessitates filing Form 990-T to report taxable business income. The presence of taxable business income may draw additional scrutiny, and if it becomes a significant part of the organization’s operations, call the organization’s tax-exempt status into question. All this to say you want documentation that shows that the organization’s expenditures are reasonable for the organization.
  • that reimbursements must be reported and booked within a reasonable period of time – in my opinion, this means that the expenses are captured within the accounting cycle, so that they are reflected in the correct accounting period (typically within a month of incurring an expense). According to the IRS, a “reasonable time” is within 60 days. -** that any excess of reimbursement over the original** expense that is NOT returned to the organization is taxable income – remember that nonaccountable and non-reimbursement plans are considered taxable income to the employee requesting reimbursement? This also applies to over-reimbursements. So, if an employee requests a reimbursement of $30 for a $27 expense, technically $3 of the $30 paid to the employee is taxable income.
  • You can add to your reimbursement policy that any excess reimbursement must be returned to the organization, to avoid tracking and reporting that additional tax liability. Identifying any over-reimbursements and recovering them from the employee is a separate discussion beyond the scope of this article and is mostly a can of worms.
  • This also applies to per diem rates in excess of the US GSA rates.

Reimbursement Policies for Nonprofits’ Contractors or Vendors

Although reimbursements to third parties (people who are not employees of the organization or are another organization) and vendors are not nearly as common as reimbursements to employees, they do happen. Reimbursements to third parties should be treated as invoices from vendors. Under limited circumstances, reimbursements to non-employee individuals may be treated like reimbursements to employees and require the same type of documentation.

Travel Reimbursement Policies for Nonprofits

Reimbursements for travel expenses are one of the most common types of reimbursements, so it’s quite reasonable to dedicate particular attention to travel reimbursements. The travel reimbursement policy should include some guiding information, including:

  • An acceptable timeline for submitting expenses
  • The budget management audit process
  • Established reimbursement rates (usually in line with government-established rates)
  • The steps to submit a reimbursement request
  • Estimated time for reimbursement approval
  • Preferred travel agencies or hotel reservation sources

The list below itemizes the information you might require on your travel reimbursement documentation. Consider creating a form that employees and board members can simply fill out and include with the receipts.

  • Travel destination / event
  • Date(s) of travel
  • Personnel involved during travel
  • Organizational purpose of the expense (if not identified in the travel destination/event)

If a personal vehicle is regularly used, the reimbursement policy should specify if and how much of these items are reimbursable, in compliance with IRS Topic #510 Business Use of a Personal Car:

  • Cost of gas (usually at the IRS-determined standard mileage rate)
  • Lease payments
  • Repair and maintenance expenses
  • Insurance and registration

It’s very common – and very acceptable – to simply use the standard, IRS-determined mileage rate for personal vehicle use. You do not have to reimburse for recurring lease payments, registration, etc., and can just use the standard rate multiplied by miles driven.

Although you should not rely on it, be aware that there are certain situations where a nonprofit may be exempt from submitting travel expense receipts to the IRS (IRS Publication 463):

  • Non-lodging costs are less than $75
  • A transport expense receipt is not readily available (the vendor does not typically produce a receipt)
  • Adoption of a per diem allowance method for out-of-town travel

What should the expense reimbursement documentation look like?

For travel reimbursements, the documentation should include a cover form with any information required by the organization (such as travel purpose and dates), and the receipts for the expenses to be reimbursed. For non-travel expense reimbursements, the documentation usually consists of the expense receipt, and possibly approval tracking. For information on what you can use to replace missing receipts, read this.

Audits and Practical Application

The reality is that collecting and maintaining expense and reimbursement documentation is almost exclusively to support an audit of some kind, whether it’s a simple matter of the accountant ensuring that the financials are correct, or the organization is undergoing a complete audit by an independent auditor. In your accounting and operations policies, it’s worth covering the subject of auditing so that all team members are on the same page and understand the purpose behind the procedures. For reimbursements, internal audits are an important part of nonprofit organization procedures. These internal audits are intended to verify that controls on reimbursements are operational, and that the procedures related to capturing, documenting, and reimbursing organization expenses are functioning properly.

All of this for small expense reimbursements may feel like overkill for small nonprofits but writing and implementing the processes is best for the organization in the long run. You can make the reimbursement process easier by implementing inexpensive reimbursement tools like Expensify and integrating them into the accounting system to minimize chasing receipts and documentation. Some payroll systems even allow employees to submit expense reports there, so the reimbursement is paid out with payroll in the next pay cycle, the approval all happens within the same system, the documentation is captured with the request, and the expense coding and amount is synced right into the accounting software with the payroll.

In practice, reimbursed expenses will show up on the financial statements in the same manner as expenses that are processed through regular bill pay, so the level of documentation should ultimately be fairly uniform across both types of expenses. A full discussion of documentation requirements – and where to draw the line – is a separate subject all on its own (covered in our discussions on how to prepare for an audit, and what to do about missing documents, but the idea is to simply satisfy any questions about the purpose of the expenditure in the case of an audit. Remember, don’t go overboard documenting every detail if it those details don’t support or explain the purpose of the expense.

What are the alternatives to reimbursements?

If you decide that reimbursements are too messy or complicated, you can opt to issue organization credit or debit cards. This option comes with a separate set of recommendations and frankly, quite a bit more risk to the organization. Get a sense of the pros and cons of credit cards vs employee reimbursements here.

Want to learn more about reimbursement policies for nonprofits?

If you have any questions about the information above, or about what the expense reimbursement policy for your nonprofit should look like, fill out this form so that we can reach back to you, or schedule a call directly with one of our advisors!