QUESTION: Our company would like to simplify reimbursements for business travel expenses by paying employees a fixed amount for each travel day regardless of incurred expenses. How can we keep the per diem payments from being treated as income to our employees, and how would those payments affect employees’ expense reporting?
ANSWER: Per diem payments are often used to simplify compliance with the accountable plan rules that allow business travel reimbursements to be excluded from employees’ gross income. Under those rules, reimbursed expenses must be substantiated—generally by submitting sufficient information regarding the amount, time, place, and business purpose of the expense. If the IRS’s per diem rules are followed, however, the per diem amount is deemed substantiated, so employees do not have to track or provide receipts for each individual expense. Employees still must substantiate the time, place, and business purpose of their travel expenses for each travel day, but when per diem payments are based on an appropriate rate, substantiation can be greatly simplified.
IRS rules establish two main per diem rate substantiation methods: the high-low method and the regular federal per diem rate method. The regular federal per diem rate method uses location-specific rates set by the federal government for its civilian employees. The rates for travel within the continental United States are available on the website of the General Services Administration. The rates for Alaska, Hawaii, and Puerto Rico are set by the Defense Department. By contrast, the high-low method uses only two rates: one for places designated as high-cost locations and another for all other locations. The high-low substantiation method may be used only if it is used for all amounts paid to an employee for travel away from home in the continental United States during the calendar year. The high-low rates for each year are published in an annual IRS notice (for an example, see our Checkpoint article). Special reimbursement rates may be used for employees in the transportation industry.
Per diems can cover lodging, meals, and incidental expenses, or just meals and incidental expenses. Amounts not covered by the chosen per diem rate could be separately reimbursed on an excludable basis, but such reimbursements would have to satisfy all of the substantiation requirements. This would offset the simplification achieved by using a per diem rate.
Under either substantiation method, per diem rates must be reasonably calculated not to exceed the incurred or anticipated business travel expenses covered by the per diem. According to IRS Publication 463, this means that the per diem rates should reflect reasonably accurate estimates of the relevant travel costs, which may vary based on location. If the reasonable calculation requirement is met, and you establish an allowance that does not exceed the amount deemed substantiated under one of the IRS-approved methods, you (and the employee) can treat the entire allowance as excludable (assuming the time, place, and business purpose of the travel have been substantiated), even if the employee didn’t use the entire allowance. If you pay more than the amount deemed substantiated under the applicable method, and you do not require the employee to timely return the excess, the excess will be income to the employee, subject to withholding and employment taxes. If you do not require employees to return amounts received for unsubstantiated travel days, all amounts will be treated as income.
For more information, see EBIA’s Fringe Benefits manual at Sections II.E (“Employee Business Expense Reimbursements”) and XXI.G (“Travel Expense Reimbursements: Substantiation”).
Contributing Editors: EBIA Staff.