Contractors go where the work is. Depending on the opportunities you pursue, this can require that employees travel away from home, which generally gives rise to per diem. Depending on the location and size of your contracts, per diem can be a significant expense, so it’s important to understand the accounting options and the new opportunity for increased tax deductions in 2021 and 2022.
Per Diem Reminders
A per diem is an allowance paid for ordinary and necessary business expenses incurred by an employee for either lodging, meal, or incidental expenses while traveling away from home. Transportation expenses, including transportation to and from the job site and between locations for meals and lodging, are handled separately. Typically, they’re treated as an actual expense that’s reimbursable to employees.
To qualify for the lodging portion of per diem, employees must stay in a qualifying secondary residence. This can be a hotel, rental home, or second home; staying with friends or family members is not considered an eligible expense for per diem purposes. The IRS allows a meals-only per diem to be paid to an employee, but a lodging-only per diem payment is not permitted.
Per Diem Rates
Daily per diem rates are set for each city and state in the continental U.S. by the General Services Administration (GSA). The Department of Defense (DOD) sets per diem rates for Alaska, Hawaii, and U.S. territories and possessions. The State Department sets rates for travel outside the U.S., which are typically updated annually in October. The IRS also establishes fixed rates for areas that have a higher cost of living.
When deciding how much to offer for per diem, you can:
- Pay the federally established rates
- Pay less than the federally established rates
- Pay more than the federally established rates (amount in excess of established rate is generally taxable to employees)
When meals and lodging are grouped into a single per diem payment, and the amount paid is less than established federal rates, the Approximate Method for accounting would apply. This method specifies that:
- 40% of the lumped per diem amount is assumed to be meals (subject to the 50% disallowance)
- 60% of the lumped per diem amount is lodging
Regarding accounting options, per diem can be classified as either wages or as a separate company expense.
Option 1: Classify Per Diem As Wages
Per diem payments from nonaccountable plans are taxable wages to the employee. This option allows your company to claim a full deduction for those benefits; however, the per diem benefits become taxable to employees. Specifically, per diem rates are taxable if you pay employees a flat rate and don’t require an expense report or pay more than the standard federal rate.
Option 2: Classify Per Diem As A Company Expense (Not Wages)
Per diem payments from accountable plans are not taxable wages to the employee. To deduct per diem as a company expense, employers must retain an expense report including the business purpose, date, and place of the employee travel.
Maximizing the 100% Meal Deduction
For companies that classify per diem as a company expense rather than wages, the regulations have changed for 2021 and 2022. Prior to January 1, 2021, qualifying meal expenses were only 50% deductible, while lodging expenses were 100% deductible. The Consolidated Appropriation Act of 2021 raised the deduction for restaurant meals to 100% effective for 2021 and 2022. IRS Notice 2021-25 clarified that restaurants are businesses that prepare and sell food or beverages to retail customers for immediate consumption, regardless of whether the food or beverages are consumed on the business’s premises. A restaurant does not include businesses that primarily sell pre-packaged food and beverages, not for immediate consumption, such as grocery stores, food kiosks, specialty stores, vending machines, convenience stores, and newsstands. There are also additional limitations related to eating facilities on the premises of an employer.
Notice 2021-25 does not explicitly address applying the 100% meal deduction to per diem payments under an accountable plan. However, since an employee or other recipient of meal per diem may use the per diem to purchase food or beverages from a source that is not a restaurant, a per diem paid without additional substantiation (i.e., a restaurant receipt) should remain subject to the 50% disallowance. If you do not currently retain receipts for per diem restaurant expenses, consider requiring employees to submit receipts for restaurant expenses to take advantage of the 100% deduction for 2021 and 2022.
Unrelated to IRS Notice 2021-25, time and materials (T&M) contracts also present an opportunity to maximize the deduction for per diem. In some instances, employers can take a 100% deduction for per diem expenses paid to employees if per diem amounts are disclosed on invoices to customers. If you think this may apply to you, get in touch with your advisor.
Alternative to Per Diem: Paying Actual Expenses
An alternative to paying per diem rates is to reimburse employees for actual expenses or allow them to use a company credit card. To deduct credit card payments or reimbursements as a company expense, businesses must retain documentation detailing the date, time, place, amount, and business purpose, as well as a transaction receipt. Individual expenditures less than $75 (except for lodging) do not need a receipt, though company policy may require them. Employers may switch between reimbursing actual travel expenses and a per diem allowance plan at any time without a formal election.
Aldrich is Here to Help
Selecting and managing a per diem policy can be complex and may require changes as your company evolves. If you have questions regarding per diem, Aldrich Advisors can help. Get in touch today to learn more and discuss solutions to the opportunities and challenges related to travel expenses.
Meet the Author
Jason Moss, CPA
Aldrich CPAs + Advisors LLP
Jason Moss joined Aldrich in 2009. He provides financial statement attestation expertise in our construction niche and oversees employee benefit plans. Prior to joining the firm, Jason worked on farms and as a concrete laborer in his hometown in Michigan. In his current role, Jason helps our construction clients by strengthening their financial reporting and…
- Audits and reviews
- Employee benefit plan audits
- Certified Public Accountant
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