When running a business, especially one that involves employees traveling, you may encounter terms like "per diem." So, what is per diem? Simply put, it's a daily cash allowance you give your employees to cover their expenses on the road—think meals, hotel stays, and so on.
The alternative is to reimburse employees after every trip. While this sounds simple, you'll have to remember to verify and keep each receipt and create an expense report for the IRS.
An easier option? You can give your employees a fixed amount of money per day, aka per diem allowance. When you pay a per diem allowance, you don’t need to keep detailed receipts—only an expense report is required for tax purposes.
While per diem is a fantastic way to manage travel expenses, it comes with its own set of tax implications, which, let's be honest, can get a little confusing.
This article will shed light on the nuts and bolts of per diem from an employer's perspective, helping you understand how it works, its impact on your company's taxes, and how to handle it effectively.
What Is a Per Diem Expense?
When businesses say they “pay per diem expenses,” they’re paying a fixed amount to their employees to cover their travel expenses for each day they’re gone. Another way to remember it? Per diem in Latin means "by the day" or "for each day."
Here's a quick rundown of the expenses per diem covers:
- Lodging: Per diem for lodging covers room rents for hotels, motels, inns, resorts, and apartments.
- Meals: Per diem covers the food and beverages (excluding alcohol) your employees buy during their travels.
- Incidental expenses: Per diem covers expenses such as room service, laundry, dry cleaning, and ironing. It also includes tips and fees for workers who provide your employees with services, such as food servers and luggage handlers.
Here, meals and incidental expenses are generally coupled under an umbrella term of M&IE.
Note that the per diem allowance doesn't cover transportation expenses, like airline tickets.
Are Travel Expenses Covered by Per Diem?
A common misconception about per diem is that it includes transportation expenses, like airline tickets. In reality, it doesn't, and there's a good reason for this.
Transportation expenses, such as flights, trains, car rentals, or mileage for personal vehicles, can fluctuate significantly based on distance, location, and method of travel. These costs can be far less predictable and far more variable than daily living expenses.
For instance, a flight to a distant location would be significantly more costly than a short car ride. Including these expenses in per diem would result in a huge discrepancy in actual costs versus allowances. To ensure that reimbursement rates are equitable and reflect actual costs, transportation expenses are typically accounted for separately from an employee’s per diem allowance.
By handling these expenses separately, businesses can more accurately and fairly reimburse employees for their actual travel costs. Understanding and explaining this distinction is crucial to avoid any unnecessary confusion from your team.
Is Per Diem Tax Deductible for Employers?
Yes, most of the per diem you pay your team is tax deductible. These are considered legitimate business expenses, essential for the performance of employees' duties. This means they can be subtracted from your company's taxable income, potentially reducing your overall tax liability.
But hold up—there are some rules. The IRS has specific limits for these deductions. The per diem rates you provide should match up with standard rates set by the General Services Administration (GSA). If you're giving more than these rates, the extra amount might get taxed.
To score these deductions, you've got to have what's called an “accountable plan.” Basically, the expenses need to be work-related, your employee needs to prove these expenses within a reasonable timeframe with receipts, and any extra allowance has to be given back to you.
Is Per Diem Taxable For Employees?
The answer can vary based on a few key factors.
If your company has an “accountable plan,” then the per diem generally isn't considered taxable income for the employees. It's viewed as a reimbursement instead.
However, there are certain conditions where per diem becomes taxable. The IRS sets standard per diem rates and if your allowances exceed these rates, the extra amount could be seen as taxable income.
For example, if the IRS rate is $50 a day for meals and your employee gets $70, the extra $20 might be considered taxable. More often than not, the excess will be treated as employee wages, meaning it’s subject to income tax.
If your company doesn't follow an accountable plan or if your employees don't provide necessary expense reports, their per diem may be fully taxable. Remember, the employee has to fill out an expense report within 60 days of the trip, containing the trip's date and place and details about the business purpose for traveling. If they don't, the per diem amount is treated as income rather than reimbursement.
Understanding these nuances is crucial to maintaining transparency and accuracy in your financial reporting and payroll processes.
Do Employers Report Per Diem to the IRS?
As an employer, you have to report how much per diem you paid your employees in your tax returns.
As you know, you can write off some of those per diem expenses to reduce your taxes. Some more detailed examples include:
- Lodging: Lodging expenses are fully tax deductible if you pay equal to or less than the federal rate (more on that below).
- Meals: The Taxpayer Certainty and Disaster Relief Act of 2020 provides 100% tax relief for expenses on food and beverages from restaurants up until Dec. 31, 2022—before that, it was 50%. For meals bought from grocery stores, vending machines, and kiosks, the deduction allowed is still 50%.
- Incidental expenses: Incidental expenses below $5 per day for an employee are deductible.
However, make sure you have the employees' expense reports to support these tax deduction claims. They won't be accepted unless you have the right paperwork in place.
How Much Per Diem Should You Pay Your Employees?
You can pay the standard rates set by the General Services Administration (GSA) or Internal Revenue Service (IRS)—it’s up to you. If you want a county-specific per diem rate, you may want to pay your employees the GSA rates. But, if you are looking for a simplified reimbursement method, follow the IRS guidelines.
Let’s take a close look at both federal rates.
IRS High-Low Per Diem Method
The IRS defines per diem rates based on the travel location. You have to pay a higher per diem rate for some locations within the continental United States (CONUS) and a lower rate for the other locations. Here, the continental United States doesn’t include Alaska, Hawaii, Puerto Rico, and U.S. possessions.
Every fiscal year, the IRS defines a combined per diem rate for lodging and meals and incidentals.
The high-low per diem rates as of Oct. 1, 2022 are:
- $297 for travel to any locality with a high cost of living.
- $204 for travel to any other locality with a low cost of living.
The meal expenses (included in the above amount) shouldn’t be more than $74 for high-cost U.S. territories and $64 for low-cost territories. Also, the incidental costs should stay within $5 per day.
The IRS doesn't define specific rates for lodging. However, if you pay employees less than the IRS rate, a good practice is to allocate 40% of the combined amount to meals and 60% to lodging.
GSA Federal Per Diem Rate Method
Follow the GSA rates if you want to pay for lodging and meals and incidentals separately. Remember, you may need to pay different rates for the standard continental U.S. territories (~2,600 counties) and non-standard (316 counties) territories.
Here are the GSA’s per diem rates for the standard continental U.S. territories (for the financial year 2023, which started on Oct. 1, 2022):
- Lodging: $98 per day.
- Meals and incidental expenses: $59 per day.
You can use the GSA’s online tool to look up the exact rates for every city.
For regions outside the U.S., check out the rates listed by the State Department. For non-foreign areas that aren’t in the continental U.S. (e.g., Alaska, Guam, and Hawaii), you can follow the rates set by the Department of Defense.
An important thing to note is that these rates are just guidelines. You can pay rates lower or higher than federal rates. But if you decide to go higher, the IRS will consider the extra amount as employee wages, and the excess will be taxable to the employee.
Paying Per Diem for Travel Expenses is the Easiest Option
As a business owner, you'll frequently have to pay for your employees’ business travel expenses. Per diem payments help simplify expense bookkeeping and reduce taxes if they’re within the federal rates.
If you don’t want to follow the per diem method, you can reimburse the exact expenses of your employees, though that can be a hassle since you need to verify, record and save every receipt.
Another alternative is to give your employee a company credit card for travel expenses. Still, the employee will need to submit the details of each expense along with their receipts. Ultimately, per diem is the easiest route to go.
One last thing worth noting is that the IRS and GSA update their rates for per diem payments every fiscal year. So be sure to stay up to date to comply with tax laws! And now that you know all there is to know about per diem rates, all that’s left to do? Start setting your budget!