2015-Issue 7—Reimbursing and substantiating business travel expenses can be cumbersome and time-consuming. It usually involves employees collecting receipts as they travel and maintaining records that note the time, place and business purpose of each expenditure. Oftentimes, there are administrative delays or questions about the business purpose of an expense item. Fortunately, the IRS offers a simpler alternative — per diems. Instead of reimbursing employees for their actual expenses while traveling, employers may pay them a per diem amount, based on IRS-approved rates that vary by location. The General Service Administration publishes annual rates for the continental United States, while the Department of State publishes annual rates for foreign countries.
A principal benefit of using per diem rates is the more lenient recordkeeping requirements. Receipts are usually not required under the per diem method. Instead, the company simply pays the allowance to the employee, who must substantiate the time, place and business purpose of the underlying travel. Additionally, qualified per diem reimbursements generally aren’t subject to income or payroll tax withholding and are not reported on an employee’s Form W-2.
Merely implementing a per diem plan does not in and of itself make such payments tax-free to employees. A per diem plan must be a qualified per diem plan in order for the per diem payments to be paid tax-free. Failure to properly administer a per diem plan that is intended to be qualified will have adverse tax implications for both employees and the employer. For a plan to be properly classified as a qualified per diem plan, the following do’s and don’ts should be taken into consideration:
- Have a Business Purpose: Qualified per diem allowances may be used only when an employee incurs, or is reasonably expected to incur, travel expenses that are ordinary and necessary business expenses, for meals and incidental expenses in connection with the performance of the employee’s services. Under the rules, employers can provide a per diem that covers lodging, meals and incidental expenses, or meals and incidental expenses only.
- Consider the Employee’s “Tax Home”: Per diem allowances are qualified as long as employees are traveling a sufficient distance away from their tax home. First, employees should establish that they have a tax home and the location of the tax home in order to be eligible for business expense reimbursement. The Supreme Court, in Flowers v. Commissioner, stated that a taxpayer must be “away from home” to deduct travel expenses. This has been determined to mean that a “sleep or rest rule” must be satisfied. This requirement is satisfied if the taxpayer must be away from home for substantially longer than an ordinary day’s work and could not reasonably be expected to make the trip without sufficient time to obtain sleep or rest. The IRS has not published any official guidelines that detail specific eligibility requirements (e.g., specific amount of miles away from tax home); however, it is generally a rule-of-thumb that the required commute must be greater than 50 miles from the employee’s tax home and the employee must be in travel status for more than 12 hours. The IRS has implemented internal guidelines for its employees that include: 1) the required commute must be greater than 40 miles from an official station or residence; 2) the per diem expenses must be incurred while performing official travel; and 3) the employee must be in travel status for more than 12 hours but less than one year.
- Confirm the Employee Has a Tax Home: An employee with no principal place of business or permanent place of residence is considered an “itinerant,” and such employees are not eligible under a qualified per diem plan because they have no tax home from which to be away. Employees may be considered itinerants if they consistently obtain temporary work assignments in different locations. To avoid complications, employers should review an employee’s prior work history to establish that the employee had a regular place of business that would be sufficient for classification as a tax home. Employees without a principal place of business may treat a permanent place of residence as their tax home. The primary factor that courts will consider in determining whether employees have a tax home is whether they incur substantial continuing living expenses. An employer should review the employee’s economic and social ties to the area, including family ties, extent of living costs and historical business activity.
- Issue Assignments on a Temporary Basis: A qualified per diem expense allowance is not allowed for employment assignments lasting over one year. If employment at a work location lasts for one year or less, the employment is treated as temporary. Moreover, the term of assignment should be for a definite period of time and documented. If the assignment is reasonably expected to last for one year or less, but it is later discovered that employment is expected to exceed one year, the employment will be treated as temporary until the date that the expectation changed, and as indefinite after that date. Additionally, an assignment is not considered temporary if the employee is given multiple assignments in the same location that collectively span over one year. This is because the one-year rule requires the employer to look at the total time spent at the temporary location. The reason for the one-year rule, with respect to employment at a single location, is that at the one-year point, the employee could reasonably be expected to move his or her residence to the location of the job site.
- Maintain Accurate Records: The requirement to substantiate each expenditure is relaxed under a qualified per diem plan; however, an employee must still maintain a log recording days worked away from home, the location where the services were performed and the business purposes of the travel, and provide the log to the employer. Even though recordkeeping requirements are relaxed under a qualified per diem plan, it is still prudent business practice to maintain accurate records while traveling on business.
- Treat Per Diem Allowances as Salary Alternatives: The split of wages versus per diem allowances should not be at anyone’s subjective discretion. Employees may not be offered the choice to accept a higher salary with no per diem or a lower salary with a per diem so that the total compensation under either approach is substantially the same. Employers should look to industry-specific and local salaries in determining their employees’ salaries.
- Treat Breaks in Assignments as Restarting the Clock: Employers need to make sure that breaks in between assignments at the same location are legitimate and not viewed as an attempt to evade the one-year rule. The IRS has issued guidance providing breaks of three weeks or less may not be sufficient. IRS Chief Counsel Advice to appeals agents and IRS audit staff recommends breaks of at least 7 months between 12-month contracts.
- Provide Allowances in Excess of the IRS-Approved Rates: Under an accountable business expense reimbursement plan, employees are required to repay any reimbursement in excess of their substantiated amount. If the employer offers a qualified per diem plan, the employee is not obligated to substantiate the amount, and thus would not have to repay the employer if the per diem allowance exceeds the employee’s actual expenses. However, if the per diem allowance offered exceeds the geographic per diem rate, the excess allowance over the applicable per diem rate will be classified as taxable income to the employee.
- Abuse the Qualified Per Diem Rules: If a per diem allowance arrangement evidences a pattern of abuse, all payments under the arrangement will be disqualified, and thus treated as normal wages subject to all applicable compensation tax rules. It is advised that employers consistently monitor the implementation of their per diem policies and the employees receiving per diems.
Alvarez & Marsal Taxand Says:
Qualified per diem plans are an excellent way to reduce the administrative burden of travel expense reimbursements and payroll tax reporting and withholding. Both employers and employees should keep the aforementioned information in mind while implementing a qualified per diem allowance plan.
The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
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