A business can reimburse its employees for travel-related expenses without creating taxable income by paying them the appropriate per diem rate. These rates differ according to how expensive the travel destination is, and most of the ones for travel within the U.S. are set by the General Services Administration (GSA).
Learn more about these rates, including when they can be used and when they can't.
What Are Per Diem Rates?
The term per diem—from the Latin for "by day"—refers to a daily allowance for specific travel expenses for employees. There are per diem rates for two separate components:
- Meals and incidentals
These rates are set by federal agencies and apply to federal government employees who are traveling for work. They are also used by the Internal Revenue Service for the purpose of determining whether non-federal-government employees owe taxes on reimbursements for work-related travel expenses.
Starting with 2019 tax returns, incidental expenses (IE) consist only of fees and tips given to porters, baggage carriers, and hotel and ship staff members. Expenses for traveling between lodging, business, and dining locations and for mailing travel vouchers and credit card bills are no longer included in IE. These transportation and mailing expenses should be reimbursed separately, as should those for laundry and cleaning services.
Employee driving expenses are also handled separately from per diem expenses. To account for driving expenses, you may be able to use actual expenses or the standard IRS mileage rate, which was 57.5 cents a mile for 2020 (decreasing to 56 cents per mile for 2021).
How Do Per Diem Rates Work?
Your business must have an accountable plan for employee reimbursement expenses in order for the reimbursements to not be treated—and taxed—as pay. If an employee follows the rules of your accountable plan, you should not include the amounts of any reimbursements in the total income reported in box 1 of their Form W-2.
Accountable Plan Criteria
To qualify as an accountable plan, the plan must reinforce three rules.
- The employee's expenses must have a business connection.
- The employee must adequately account to you for these expenses within a reasonable period of time.
- The employee must return any excess reimbursement or allowance within a reasonable period of time.
The employee should include in their expense reports the amount, time, place, and business purpose of each lodging, meal, or incidental item.
The Internal Revenue Service states that "a reasonable period of time" varies according to each individual situation, but it provides examples of actions that would be considered to have occurred within a reasonable period of time.
- The employee receives an advance within 30 days of the time they had an expense.
- The employee adequately accounted for their expenses within 60 days after they were paid or incurred.
- The employee returned any excess reimbursement within 120 days after the expense was paid or incurred.
- Your company gives a periodic—at least quarterly—statement that asks employees to either return or adequately account for outstanding advances and the employee complies within 120 days of the statement.
An excess reimbursement or allowance is any amount an employee is paid that is more than the expenses they accounted for to their employer.
If an employee follows the rules of your accountable plan, you should not include the amounts of any reimbursements in the total income reported in box 1 of their Form W-2.
Per Diem Use Criteria
The IRS considers your company's use of the per diem allowance to be proof of employees' expenses if four criteria are met.
- You limit payments of their expenses to those that are ordinary and necessary in the conduct of the trade or business.
- The allowance is similar in form to and not more than the federal rate.
- They prove the time, place, and business purpose of their expenses to you within a reasonable period of time.
- They aren’t related to you.
If they are related to you and/or fail to meet any of the other criteria, they must be able to prove their per diem expenses to the IRS.
How Per Diem Rates Are Set
The General Services Administration sets the per diem rate for each city and state within the continental (also known as contiguous) United States (CONUS). Per diem rates are larger in higher-cost areas, and in some cases, they also vary according to the time of year. Costs for hotels, meals, and other typical travel expenses can vary widely from one city to another and from winter to summer.
The Department of Defense (DOD) sets the per diem rates for Alaska, Hawaii, and U.S. territories and possessions, which is called OCONUS (outside the contiguous United States) for short. The Department of State (DOS) sets per diem rates for other countries.
The per diem rates get updated every year, usually on October 1, with the beginning of the U.S. government's fiscal year.
For CONUS destinations, the per diem rate for lodging excludes taxes. And on the first and last days of travel, the per diem rate for meals and incidentals (M&IEs) is 75% of the full-day amount.
If your employee is traveling to two cities on the same day, they should use the rate for the location where they are sleeping.
Finding Per Diem Rates
Alternatives to Per Diem Rates
You can choose to reimburse your workers for their actual travel expenses or a flat rate for each trip, but the employees will be expected to pay tax on the amount that exceeds the per diem rate and you will have to pay employment taxes as well.
Instead of using the actual per diem rates for each location, your company's employees may utilize a high-low method that consists of one rate for all high-cost destinations and a lower rate for all other destinations. As of Oct. 1, 2020, the rate for high-cost locations is $292, including $71 for M&IE. For all other locations, it's $198, including $60 for M&IE.
Some locations are considered to be high-cost only during certain times of the year. For example, seaside destinations in northern states are high-cost during the summer months but low-cost the rest of the year.
Tax Deductions on Per Diem Rates
Your business may deduct 100% of the amount reimbursed to an employee for lodging expenses but only 50% of the amount reimbursed for meal expenses. Your employees may deduct 50% of the unreimbursed cost of meals above the per diem rate. There is no deduction for costs for which they were reimbursed.
You may wish to seek advice from a tax professional before establishing a per diem or other type of employee reimbursement system for travel-related expenses.
- Your business can reimburse your employees for lodging, meal, and incidental expenses incurred while traveling by paying them the appropriate per diem rate.
- These rates differ according to how expensive the travel destination is and sometimes the time of year.
- They are used by the Internal Revenue Service to determine whether non-federal-government employees owe taxes on reimbursements for work-related travel expenses.
- Rates for the continental U.S. are set by the General Services Administration. Those for Alaska, Hawaii, and U.S. territories and possessions are set by the Department of Defense. And those for other countries are set by the Department of State.
The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney.