What is the federal income tax treatment for an employer that pays per diems for employees who travel out of state?
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The federal income tax treatment for an employer that pays per diems to employees who travel out of state is governed by a combination of Internal Revenue Code (IRC) provisions, Treasury Regulations, IRS guidance, and established administrative practices. The key considerations are whether the per diem payments are made under an accountable plan, the substantiation requirements, and the tax consequences for both the employer and the employee.
1. Accountable vs. Nonaccountable Plans
- Accountable Plan: If the employer’s per diem arrangement meets the requirements of an accountable plan, the per diem payments are not treated as wages, are not subject to income or employment taxes, and are not reported on the employee’s Form W-2. The requirements are:
- The expenses must have a business connection (i.e., incurred while performing services as an employee).
- The employee must substantiate the time, place, and business purpose of the travel within a reasonable period.
- The employee must return any excess reimbursement within a reasonable period.
- Nonaccountable Plan: If any of the above requirements are not met, the per diem payments are treated as wages, subject to income tax withholding and employment taxes, and must be reported on Form W-2.
2. Eligibility for Per Diem Treatment
- The travel must be business-related and require the employee to be away from their tax home overnight or long enough to require rest or sleep. Commuting or day trips do not qualify.
- The per diem rates must not exceed the federal per diem rates for the locality of travel, as set by the General Services Administration (GSA) for lodging, meals, and incidental expenses.
3. Substantiation and Documentation
- Even when using per diem rates, employees must substantiate the time, place, and business purpose of the travel. Receipts for lodging are not required if the per diem method is used, but documentation of the business purpose and travel details is necessary.
- If the per diem paid exceeds the federal rate, the excess is treated as paid under a nonaccountable plan and is taxable to the employee.
4. Tax Consequences for the Employer
- Deductibility: The employer may deduct the per diem payments as business expenses under IRC §162, provided the arrangement is an accountable plan and the expenses are ordinary and necessary business expenses incurred while traveling away from home.
- Reporting: Payments under an accountable plan are not reported as wages. Payments under a nonaccountable plan are included in wages and reported on Form W-2.
5. Special Rules and Limitations
- Meals and Incidental Expenses (M&IE): The per diem for M&IE is subject to a 50% deduction limitation for the employer under IRC §274(n), except for certain transportation industry employees who may be eligible for an 80% deduction.
- High-Low Substantiation Method: Employers may use the high-low substantiation method for travel within the continental U.S., applying a single rate for high-cost and another for low-cost localities, as published annually by the IRS.
- State Legislators: Special rules apply for state legislators under IRC §162(h) and Treas. Reg. §1.162-24.
6. Common Pitfalls
- Non-qualifying Travel: Per diem payments for travel that does not require an overnight stay or is not business-related are not deductible and are taxable to the employee.
- Failure to Substantiate: If the employer does not require substantiation or does not require return of excess amounts, the plan is nonaccountable, and all payments are taxable.
7. Summary Table of 2025 Per Diem Rates (for Reference)
- M&IE (Transportation Industry, CONUS): $80 per day
- High-Low Method (CONUS): $319 (high-cost), $225 (low-cost) per day
- Incidental Expenses Only: $5 per day
8. Conclusion
If an employer pays per diems for employees who travel out of state, and the arrangement qualifies as an accountable plan, the per diem payments are not taxable to the employee and are deductible by the employer, subject to the 50% meals limitation. Proper substantiation and adherence to federal per diem rates are essential. If the arrangement does not meet accountable plan requirements, the payments are treated as taxable wages.
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