In Latin, per diem means either "by the day" or "for each day." Its English meaning is similar, with the term used to describe money owed to someone for daily charges. Rather than tracking every single expenditure, a business may offer employees a daily rate for some or all of their expenses. Although per diem rates are in the IRS’s guidelines, if an employee is being paid a per diem rate, generally this amount is not reportable on taxes. Businesses are allowed to use per diem rates to reimburse employees for expenses without it being considered taxable income, as long as the rate falls below the federal daily maximum.
TL;DR (Too Long; Didn't Read)
With a per diem rate, an employee is provided a fixed daily amount to reimburse business travel expenses.
Per Diem Definition
A per diem rate is a daily allowable rate offered to employees who incur expenses. It may also be provided to individuals invited to speak at conferences or to travel for other all expenses paid purposes. Instead of tracking every dollar spent and turning in receipts, per diem rates allow people to travel freely, as long as they stay within a specific budget.
Since some businesses book air transportation, car rentals and hotels, with the bills sent directly to the business, a per diem rate may be used solely to cover expenses like meals, entertainment and other incidentals. As long as the business stays within the federal maximums for per diem payments, they don’t have to claim the payments to employees as taxable income. For employees who travel extensively for work, per diem rates can make it easier to focus on business rather than collecting receipts and sending them to HR.
Qualifying for a Per Diem
Per diem rates are intended to be applied to travel where an overnight stay is involved. If the employee is on a day trip, in other words, that daily rate may not necessarily apply. However, often when traveling, an employee has partial days at the start and/or end of the trip. In that case, businesses can take the example set by the federal government, which reimburses federal employees 75 percent of the total meals and incidental expenses for those days. You may also choose to prorate the amount you reimburse, issuing one dollar amount if the employee was traveling for two meals and another if the trip only included one meal.
Per diem rates are not intended to include the cost of lodging or transportation. That is either paid by the business directly or reimbursed separately. Per diem rates are designed to pay all meals and other expenses incurred while traveling. Those generally include the tips given to employees like baggage handlers and porters, as well as room service fees. It also covers the cost of incidentals like snacks and coffee that are often purchased while on the road. Since it’s a per diem rate, the business generally doesn’t need to concern itself with whether or not the purchases were lavish or modest, since the employee won’t be reimbursed if the maximum for each day is exceeded. Without a per diem, the employee would be responsible for turning in receipts and making sure each request met company guidelines.
Maximum Allowed Per Diem Rates
Businesses are free to set per diem rates as they deem appropriate. Some businesses have set per diem rates, while others have separate rates for high-cost travel locales like New York City and Los Angeles. The IRS also adjusts per diem rates based on the destination of the person doing the traveling, not the location of the business making the payments. These high-cost localities include San Francisco, Boston, New York City and the District of Columbia, but for 2019 several cities have been added to the list, including Oakland, California; Lewes, Delaware; Fort Myers, Florida; Hyannis, Massachusetts; Petoskey, Michigan; Portland, Oregon and Vancouver, Washington.
Unlike other tax laws, though, the rates for localities take effect Oct. 1 each year rather than Jan. 1. It’s also important to note that some areas are high-cost localities only during peak seasons. Cities this applies to include Aspen, Colorado; Denver/Aurora, Colorado; Telluride, Colorado; Vail, Colorado; Bar Harbor, Maine; Ocean City, Maryland; Nantucket, Massachusetts; Philadelphia, Pennsylvania; Jamestown/Middletown/Newport, Rhode Island and Jackson/Pinedale, Wyoming. If your employees travel to these areas, you’ll have to check the calculator on an ongoing basis to make sure the rate you’re paying doesn't exceed the maximum for that time of year.
Business Expenses and Taxes
When your employee has an expense related to your own business, you are responsible for paying it. Whether that’s a cab fare or supplies for a conference session, the money for the expense comes out of the company budget. A per diem rate can cover employees while they’re traveling, but every reimbursed dollar will need to be reported to the IRS. However, it’s important to put something in writing detailing your policies regarding per diem rates and employee payouts for expenses. Your employees should understand how much will be reimbursed and what they’ll need to do to ensure funds are deposited without delay.
Even though you don’t have to provide receipts for per diem payouts to employees, you still will need to be able to document the expense. For each trip, you should have an expense report from the employee that shows the time, place and business purpose of the trip that triggered the expenditure. Urge your employees to keep a copy of any paperwork they submit.
Accountable Versus Nonaccountable Plan
Whether or not expense reimbursements are taxable depends on the type of plan your business uses. To pay employees without taking taxes out on the amount, you’ll need to be on the accountable plan. This will allow you to reimburse employees for expenses without withholding income taxes, FICA or unemployment taxes. In order to qualify as an accountable plan, the person turning in the expenses must be an employee, the expenses must have been incurred while that employee was conducting services related to your business and the amount can only have been for the expense itself, not as part of agreed-upon wages. Your employee will also need to have provided documentation of the amount, time, place and purpose and, if you overpay, the excess must be returned within a reasonable timeframe.
The alternative to an accountable plan is a nonaccountable one. Although this does require you to report the income and withhold taxes, it offers an element of freedom. You can pay expenses on a nonaccountable plan in lieu of wages, for instance, or pay a set per diem rate without regard for whether the employee will have a business expense that day. Best of all, the employee is not responsible for filing expense reports or returning overages in a timely manner under a nonaccountable plan. But you’ll need to report these payouts on Form W-2.
Expenses for Small Businesses and Contractors
Are travel expenses 100 percent deductible? That question only applies to independent contractors. Those with employers turn the costs over to the business to reimburse. But contractors may have their expenses reimbursed by the person paying them an agreed-upon fee. This is where things get a little complicated. It’s important that the worker and the business be able to document which payments were reimbursements and which were wages. Having a set hourly or project rate clearly outlined in writing can help with that. If the client has agreed to a per diem rate for these reimbursements, that needs to be documented as well, with expense reports to support the money spent.
If the travel expense isn’t related specifically to client business, though, the contractor can claim it when itemizing deductions on his taxes. Since per diem rates won’t apply in this instance, the freelancer will need to keep receipts and be able to state the reason for the expense and show that it was business related.
Deductible Expenses for Meals
For self-employed individuals and small-business owners, “Are meals tax deductible?” is usually a key question. There’s no one to reimburse them for the costs they rack up, but the good news is that they can tax deduct those expenses. But in the case of meals, there are restrictions. Although you’ll still be able to claim 50 percent of meals you consume as part of doing business, there are now limits on what’s covered if you have a business event catered. You can only claim 50 percent of food and beverages provided in this way and in 2025, the deductibility of that will go away altogether.
It’s also important to note the changes to entertainment expenses under the new tax law. Until the Tax Cuts and Jobs Act, taxpayers could tax deduct up to 50 percent of business-related entertainment expenses. If front-row seats at a Broadway play helped close the deal with a lucrative client, the expense could be deducted. But that option has been eliminated under the new tax law. You will find that some expenses fall in a gray area, though. Instead of taking a client to a comedy club for drinks and dinner, in other words, you might want to stick with a place that only serves drinks and dinner. But if you reimburse an employee for those costs, that money is still not taxable as income, even if it’s a meal or entertainment.
Per Diems and W-2s
Once you’ve answered the question, “are meals while traveling 100 percent deductible?” you may wonder how to report per diem payments to the IRS. If the expenses meet the IRS’s requirements for nontaxability under an accountable plan, there’s no need to report the income. It’s important to save all corresponding documentation in case the IRS asks for it or you’re audited at a later date. Employees should save their copies of documentation as well, since they’re subject to being audited on the payments.
If, however, the payment was part of wages or not documented in accordance with IRS guidelines, thereby qualifying as nonaccountable, you’ll need to report it along with the other income and wages paid on the employee’s W-2. The employee will see all of this in Box 12 of the W-2.
Unreimbursed Employee Expenses
If the employer’s per diem payout exceeded the federally allowed per diem rate, the amount must be reported as wages. Until the Tax Cuts and Jobs Act, employees could deduct any excess as unreimbursed employee expenses, as long as their total unreimbursed expenses exceeded 2 percent of their adjusted gross income. Under the new tax code, though, those expenses can no longer be deducted. Proponents of the new tax bill say the near doubling of the standard deduction will make up for it, but for employees with significant itemized deductions each year, the change will be noticeable.
It’s important to note that the change only applies to payrolled employees. Those working as independent contractors or running their own businesses can still deduct business expenses, including travel costs. They’ll be subject to the meal and entertainment expense restrictions, though, and they’ll need to keep receipts and documentation of every expense. Itemizing deductions is one of the primary ways those without employers offset the taxability of the income they earn each year.
- Merriam-Webster: How to Use 'Per Diem' in a Sentence
- Forbes: IRS Announces New Per Diem Rates For Taxpayers Who Travel For Business
- U.S. General Services Administration: requently Asked Questions, Per Diem
- Investopedia: Incidental Expenses
- GSA: Per Diem Rates
- JustWorks: What is Employee Expense Reimbursement and How Does it Work?
- IRS: Per Diem Payments
- CPA Practice Advisor: Tax Reform Law Makes Changes to the Meals & Entertainment Deduction
- IRS.gov: Topic Number 514 - Employee Business Expenses
- CNBC: New tax law takes a hatchet to these worker expenses