Let me speculate on what I know until a real expert replaces this with something better... The Vanguard S&P 500 actually uses derivatives for the last few percent of it's holdings. So very roughly speaking, it's holding 95% stocks, and some leveraged options for the last 5%. That allows Vanguard S&P 500 to keep a cash reserve for expenses and people selling their shares.
So my educated guess is the fund expenses come out of the fund's cash. That cash in turn helps act as margin for derivatives, and those derivatives track the S&P 500. That's how Vanguard S&P 500 gets so close to it's target index while investors are buying and selling.
I suppose the one liner is "expenses / expense ratio is paid (quarterly?) from the fund's internal cash account."