The ins and outs of travel costs reimbursement
By Joseph C. Smith
Many staffing companies reimburse their contingent workers on assignment away from their homes for lodging and meals.
Often, they will utilize the per diem method (“per diem” means “per day”) of reimbursement for these payments instead of requiring receipts. While this simplifies the process by which employees are reimbursed, the concept of a per diem process generates confusion and puzzling practices among employers.
What Are Per Diems?
Whenever an employee incurs expenses for lodging and meals, an employer can reimburse for these costs on a tax-free basis because the employee could, in the absence of a reimbursement, deduct the expense on their tax return as an unreimbursed business expense. If the reimbursement is processed properly, it is not included in taxable wages, nor is it subject to employment taxes.
For the reimbursement to receive this treatment it must fall under what the IRS refers to as an accountable reimbursement plan, where an employee is required to “adequately account” to the employer for their expenses. In a perfect world, this means that the employee provides the employer with receipts for every meal and every night of lodging. Processing these receipts creates an incredible administrative burden for companies with a high volume of traveling workers, such as travel nurse providers.
Enter the concept of a “per diem” — per diems are the maximum daily amounts set by the IRS for lodging and meals that an employer can pay an employee without receipts, provided that the time, place and purpose of the expense is clearly established. The rates are standardized by the IRS by location and are updated annually in October and as the need arises. IRS Publication 1542 lists these rates and they can also be found on the Government Services Administration, the Department of Defense and State Department websites.
If an employer pays an amount in excess of the per diem rate, a receipt is required or the excess is deemed taxable.
In essence, per diems are an alternative to actual receipts that are acceptable to the IRS and satisfy the requirements of an accountable reimbursement plan. The fact that the employee may or may not spend all of the allowed per diem payment is irrelevant to the IRS. The mere existence of an expense is the trigger that allows the per diem. The excess is disregarded by the IRS because the per diem rates function as a substitute for the receipt. This causes some confusion among payroll managers, CFOs and employees, but it is a nuance of our tax regulations. In theory, the administrative expenses saved by not tracking receipts outweigh any forfeited tax revenue on the excess amounts received.
The Mechanics of Per Diems
While the payment of a per diem seems straightforward, there are some rules that can catch payroll managers unaware. First, 50 percent of meal allowances are deductible to the company, in general, the same rate for individual employees who claim a meal allowance on their tax return.
One of the few times that meals are 100 percent deductible is when the staffing agency passes the cost of the meal allowance to the client (the organization requesting the temporary staff) and the client accepts this assignment of costs. Otherwise, whenever the staffing agency provides a meal allowance, the 50 percent deduction applies. This will be reflected on the corporate tax return as well.
Second, the IRS sets maximum rates for lodging and meals separately, within the overall total. The IRS considers any allowance that is less than the published rate to be part lodging and part meals. Generally, there is no such thing as a lodging-only allowance. For example, if the published per diem for a given city is $100 a day for lodging, $50 for meals, the agency would deduct $100 for lodging, but only $25 for the meal allowance given to the employee (50 percent of $50) assuming they paid the maximum allowed. If the company pays a per diem less than the aggregate of the lodging and meal allowance ($150), then the payment must be allocated 60 percent for lodging and 40 percent for meals. For example, a $100 a day allowance would be recorded on the employer’s tax return as a $60 deduction for lodging and a $20 deduction for meals (50 percent of $40).
Abuses and Missteps
As a tax consultant specializing in the various contingent staffing industries, I see the use of a per diem reimbursement method as a preferred approach to alleviate the administrative requirements. At the same time, there are plenty of abuses. The abuse of per diems or any reimbursement program carries the risk of an IRS audit and substantial penalties when a company is found to be in violation of the rules. The following abuses are a sample of those I have seen within the staffing industry.
Housing-only allowances. Some companies merge meal payments into lodging allowances in order to circumvent the 50 percent deduction mentioned earlier. Merely calling the payment a housing allowance does not change the requirement for allocation. However, if an employer reimburses for the actual costs of the lodging, with receipts, or pays for it directly to the hotel or other facility, the meal allowance is not required.
Lack of Substantiation. An employer is required to perform reasonable due diligence to screen an employee’s tax home — residential — status. Without a “tax home,” all reimbursements are considered taxable wages to the employee. Some agencies pay tax-free amounts to individuals who are actually commuting to assignments from their primary homes.
Substitute for wages. Because reimbursements are not subject to income or employment taxes, some firms may be motivated to “recharacterize” wages as reimbursements. An employee can never be given the option to choose a tax-free reimbursement in lieu of a taxable wage.
A couple of years ago, some firms in the construction industry were offering employees an option of converting a portion of their wages (often $3 per hour or a similar amount) to a reimbursement account for tools and equipment. A number of these firms were audited as a part of a national IRS effort and penalized. To avoid the appearance of “recharacterizing wages,” employment terms should always start with a wage and then add reimbursements. Never should the two mix or be dependent upon another.
Reimbursements quoted on an hourly basis. Some firms quote lodging and meal allowances as an hourly component of compensation, a practice the IRS frowns upon. Per diems are reimbursements for expenses incurred in doing the work for which wages are paid, and the IRS does not see the two mingling. Per diem payments are daily amounts and should be presented as such. The risk here extends beyond the IRS to state workforce agencies and unemployment commissions, which will potentially view any per diem paid on an hourly basis as a wage.
Using a per diem method of travel reimbursement is a great tax saving device, when used appropriately, and simplifies the reporting process for employees who travel in the course of their employment. The confusion surrounding per diems is understandable. Following the applicable rules will not only avoid an adverse audit but reduce the attention that a particular sub-segment of the contingent staffing industry could attract from the IRS.
Joseph C. Smith is an Enrolled Agent admitted to practice before the IRS. His firm is Joseph C. Smith Tax Consultants (www.josephcsmith.com or www.traveltax.com). He can be reached at firstname.lastname@example.org.