What is per diem and how does per diem allowance work?
Per diem tax rules is an integral part of business travel expense management. When employees incur out-of-pocket expenses for business travel, stay, meals, and other incidental expenses companies reimburse these employees in the form of per diem allowance.
Per diem is Latin for “for each day”. While per diem rules differ from country to country it is the general terminology used to refer to the daily allowance employees get while on business trips. Employers provide per diem allowance as reimbursements for expenses such as travel, lodging, food, etc. incurred by employees while on the job.
What does per diem include?
Per diem includes a fixed amount that an employer pays to its employees to cover travel-related incidental expenses incurred while on the job. Also known as a scale rate payment, per diem allowance covers expenses like food, travel, and lodging. The underlying rule that governs such travel expenses is that the employee’s performance on that job, in relation to business objectives, must be directly related to or influenced by the expenses made.
Different governments have their own state-approved travel allowance benchmarks. These benchmarks put caps or limits on factors like maximum lodging costs, cost of living range, and travel regulations. Individual cases, however, can be exempted and evaluated on typical costs.
Related read- Guide to improve corporate travel policy compliance
How does per diem allowance work?
While the specifics of how per diem will work depends on which country your business operates in, there are two general approaches. These are:
Standard per diem rates
The first approach is where you calculate your rates as per the per diem allowances standardized by your country’s government. For example, General Services Administration or GSA rules in the continental United States (CONUS) or the Homeland Revenue and Customs or HMRC rules in the UK.
This is a pretty straightforward, easy ‘one-size-fits-all’ approach you can use without much administrative burden. All you need to do is look up the rates and implement them. However, adopting standardized rates might be easy, but it often falls short of employee requirements and tends to be rigid, lacking flexibility.
Company-determined rates
Another approach is where company administration itself determines what per diem rates it is going to offer traveling employees. These rates are usually calculated with reference to historical travel expense data.
Even though this approach does offer a certain degree of flexibility it is, however, much more expensive and labor-intensive. There’s also a requirement for data that is not always readily available.
Is per diem taxable?
No, per diem allowances are not always taxable given that they’re not included in employees’ standard wage. There are, however, special circumstances under which they can fall under the category of taxable income.
When filing an income tax return you are still required to include a per diem for business travel. These, however, do not form a part of the tax amount owed to employees.
According to per diem tax rules, per diem expenses become taxable only when the conditions given below are true. Ensure your employees are made well aware of these and are also strictly instructed to steer clear of them:
● Per diem becomes taxable if your company allows a flat amount higher than the rates standardized by your government.
● If travel expense report filing to the employer is not done timely it becomes taxable.
● If the expense report has essential information left out, missing, or incorrect it becomes taxable.
● An expense report was not requested by the employer when giving per diem.
Why do per diem rates differ by location?
There’s actually a very simple explanation behind why per diem rates differ from location to location. It is because not everything costs the same everywhere. Generally speaking, per diem rates for a particular location are determined by the cost of living required by that location.
Living in, say, New York will not cost the same as when an employee has to live in Tulsa. These rates are calculated annually, they change as per the market and are also determined by seasonal demand and supply changes for particular amenities.
Are per diem payments included in wages?
Per diem allowances and payments are not included in an employee’s wages. Whether it is based on standard regulations or company-specific parameters, per diem expenses are separate from the standard wages an employee is owed.
According to per diem tax rules, there are a few specific circumstances under which per diem is considered to be a part of wages and therefore also taxable. These conditions have all been discussed in the section titled ‘Is per diem taxable’.
Is per diem tax-deductible for employers?
Not only is per diem allowance not included in employee wages but it also counts as tax-deductible for employers. If standard criteria are met then companies can easily avail per diem tax deduction when they file taxes.
Employers can recover up to 50% of per diem expenses spent on meals and incidentals. Accommodation and lodging are fully deductible as long as costs are under the standardized limits. To avail of these tax deductions, employers must ensure all expense reports are obtained and kept safely for submission.
How do I prepare my per diem report to avoid problems at tax time?
Both employer and the employee have to bear the tax burden of per diem expenses. Paperwork needs to be filed by both parties along with substantiating documentation.
If you’ve created expense reports you’ll find filing a per diem pretty easy. They follow a similar process and where you send them (federal and/or state department) will depend on your company’s location.
When preparing per diem reports what you need to be particularly wary of are errors or mistakes in the report. According to per diem tax rules, if there are any discrepancies in the report then your employee might end up being taxed for something they should not be paying for.
In order to keep data organized and information at hand make sure employees are submitting receipts for their travel expenses, regardless of whether it is legally required or not.
Ensure that they submit substantiating documents every time they submit an expense report, this can also help you manage expenses when there are multiple traveling employees.
Moreover, to avoid errors and save time, check the reports and documentation submitted by employees. Vet these documents to ensure all information is present, verifiable, and error-free. Some information on these documents that are easily missed include:
● Traveling dates
● Vendor or supplier names for places where the expense was incurred
● Receipts for the expenses
● Brochures, tickets, or other documents highlighting the purpose behind travel
Ensure this information, receipts and reports are checked and streamlined to avoid problems during tax filing and stay in line with per diem tax laws.
How do you calculate per diem for taxes?
There are three steps you must follow in order to calculate per diem for taxes:
1. Check the expense reimbursement policy your company has in place and find out the per diem rates for the expenses in question. For instance, lodging is often fully reimbursable so check if the expense amount is below the standardized rate.
2. Next, check whether the days traveled by the employee are all falling under the reimbursable period outlined by your company reimbursement policy.
This is not always universally accepted. For example, if your employee arrives in the middle of a day and leaves two days later in the evening then it won’t be three full days of travel.
3. Finally, calculate per diem by multiplying the number of days traveled by the employee with your company per diem allowance rates.
For example, if the employee in question travels for four days when you provide a per diem allowance of $20 for food and beverages, the total per diem for food will be 4*$20, or $80.