How can a business structure per diem payments to employees to reduce nondeductible meal expenses and avoid a significant addback to income?
Ask Blue J any tax question, then go deeper. Follow up, add client-specific context, and explore the sources behind every answer with Blue J’s generative AI solution for tax research.
To structure per diem payments in a way that reduces nondeductible meal expenses and avoids a significant addback to income, a business must carefully design its reimbursement arrangements to comply with IRS rules for accountable plans and per diem substantiation. Here’s a comprehensive explanation of the relevant legal details and best practices, based on the sources:
1. Use an Accountable Plan
Definition and Requirements:- An accountable plan is a reimbursement or allowance arrangement that requires: 1. Expenses to be incurred while performing job duties (business connection). 2. Employees to substantiate expenses (e.g., with receipts or per diem substantiation) within a reasonable time. 3. Employees to return any excess reimbursement within a reasonable period.
Tax Consequences:- Amounts paid under an accountable plan are not considered wages, are not included in the employee’s income, and are not subject to income or employment taxes.- Amounts paid under a nonaccountable plan (i.e., if any of the above requirements are not met) are treated as wages, included in income, and subject to employment taxes.
2. Per Diem Substantiation Methods
General Rule:- The IRS allows employers to use per diem rates (rather than actual expenses) to substantiate lodging, meal, and incidental expenses for employees traveling away from home on business.
Types of Per Diem Rates:- Federal Per Diem Rate: Set by the GSA for each locality.- High-Low Substantiation Method: IRS designates certain high-cost localities with a higher per diem rate; all other areas use a lower rate.- Special Transportation Industry Rate: A flat rate for employees in the transportation industry.
Key Structuring Points:- The per diem allowance must not exceed the applicable federal per diem rate for the locality of travel.- If the per diem paid is less than or equal to the federal rate, and the employee substantiates the time, place, and business purpose, the amount is deemed substantiated and is not included in income.- If the per diem exceeds the federal rate, the excess is treated as paid under a nonaccountable plan and must be included in the employee’s income and is subject to employment taxes.
3. Avoiding Nondeductible Meal Expense Addbacks
Deductibility Limitation:- Under IRC §274(n), only 50% of business meal expenses are deductible (80% for certain transportation workers subject to DOT hours of service limits).- The 50% limitation applies to both actual expenses and per diem amounts allocated to meals and incidental expenses.
Structuring to Minimize Addbacks:- Separate Lodging and M&IE: If possible, structure per diem so that lodging is reimbursed based on actual receipts and only meals and incidental expenses (M&IE) are paid as a per diem. This allows the business to clearly identify the portion subject to the 50% limitation.- Use the Federal M&IE Rate: Pay no more than the federal M&IE rate for the locality. Any excess is treated as compensation and is fully nondeductible as a meal expense, increasing the addback.- Account for Partial Days: Prorate the per diem for travel days (departure/return) using ¾ of the daily rate or another reasonable, consistent method.
4. Documentation and Substantiation
- Employees must substantiate the time, place, and business purpose of travel, even when using per diem rates.
- The employer must require employees to return any per diem paid for days not actually traveled (unsubstantiated days), or the entire arrangement may be treated as nonaccountable.
5. Practical Steps for Businesses
- Adopt a Written Accountable Plan: Clearly state the requirements for substantiation and returning excess reimbursements.
- Set Per Diem Rates at or Below Federal Rates: Use the GSA-published rates for each locality, or the high-low method if preferred.
- Require Timely Substantiation: Employees must provide details of time, place, and business purpose within a reasonable period (typically 60 days).
- Require Return of Excess: Employees must return any per diem paid for unsubstantiated days within a reasonable period (typically 120 days).
- Monitor for Abuse: Ensure the plan is not used to recharacterize wages as nontaxable reimbursements, or the IRS may treat all payments as made under a nonaccountable plan.
7. Special Considerations
- Related Parties: The per diem substantiation method does not apply if the employer and employee are related as defined in IRC §267(b) (with a 10% threshold).
- Pattern of Abuse: If the plan routinely pays per diems in excess of substantiated amounts without requiring return or treating the excess as wages, the IRS may treat all payments as made under a nonaccountable plan.
In summary: To minimize nondeductible meal expense addbacks and avoid income inclusion, businesses should use an accountable plan that pays per diem allowances at or below the federal rates, requires substantiation of time, place, and business purpose, and requires return of excess payments. Only the portion of per diem allocated to meals and incidental expenses is subject to the 50% deduction limitation, and any excess over the federal rate must be treated as taxable wages. Proper documentation and compliance with IRS rules are essential to maintain deductibility and avoid unfavorable tax consequences.
Was this answer helpful?
What Blue J customers are saying
“We are excited to use Blue J to elevate the initial work product our team is able to produce."
"We’re incorporating Blue J to ensure our people are well-equipped with a research tool that delivers on both ease of use and quality of deliverable. It will save us a lot of time as a starting point, so we can focus our efforts on the analysis. Ultimately, it helps us get to the right answer, faster.”
"We’re incorporating Blue J to ensure our people are well-equipped with a research tool that delivers on both ease of use and quality of deliverable. It will save us a lot of time as a starting point, so we can focus our efforts on the analysis. Ultimately, it helps us get to the right answer, faster.”
"We had used Checkpoint for a long time but found it wasn’t particularly well-used in our practice."
"A lot of our practitioners would have to turn to Google to find what they were looking for, which of course isn’t ideal. Blue J is a real game-changer when it comes to this, since it combines the efficiency of Google with the authoritative tax materials our people really need to serve their clients best. At ELO, we pride ourselves on providing services that are focused on value for clients and exceeding their expectations. Adding Blue J to our toolbox will enable us to do just that, as we continue to evolve our service offerings to better serve our clients’ needs.”
"A lot of our practitioners would have to turn to Google to find what they were looking for, which of course isn’t ideal. Blue J is a real game-changer when it comes to this, since it combines the efficiency of Google with the authoritative tax materials our people really need to serve their clients best. At ELO, we pride ourselves on providing services that are focused on value for clients and exceeding their expectations. Adding Blue J to our toolbox will enable us to do just that, as we continue to evolve our service offerings to better serve our clients’ needs.”
"We find this tool to be a game-changer for us and our clients.”
“We had the opportunity to pilot some other AI solutions in the market, and found that the improvement over traditional search was limited - except in Blue J’s case, where the efficiency gain over traditional research methods is significant."
“We had the opportunity to pilot some other AI solutions in the market, and found that the improvement over traditional search was limited - except in Blue J’s case, where the efficiency gain over traditional research methods is significant."
“Blue J is an exciting technology because it enables the practitioner to remain in the driver’s seat of the analysis."
"Thoughtful functions are included to encourage and facilitate deeper analysis, not to replace or reduce it. We’ll continue to find new and impactful ways to leverage the technology, which has benefited our clients and staff alike. At RSM we strive to be compelling to our clients and to be digital by embracing new technologies to fulfill that promise.”
"Thoughtful functions are included to encourage and facilitate deeper analysis, not to replace or reduce it. We’ll continue to find new and impactful ways to leverage the technology, which has benefited our clients and staff alike. At RSM we strive to be compelling to our clients and to be digital by embracing new technologies to fulfill that promise.”
"We wanted to have a tool that people were using at all staff levels."
"We wanted something that lived up on their third screen - something that would be available and helpful to them every day. What we've found is it's been easy to get people to get into the habit of using Blue J because it helps people. Blue J allows us to quickly respond to client questions in a way that they can understand it, which helps us deal with the volume of client questions that come in. We were up and running very quickly with Blue J - within 5 minutes, our staff understood how this will be helpful, and the rest of the training program is refining prompting skills and building use cases and best practices."
"We wanted something that lived up on their third screen - something that would be available and helpful to them every day. What we've found is it's been easy to get people to get into the habit of using Blue J because it helps people. Blue J allows us to quickly respond to client questions in a way that they can understand it, which helps us deal with the volume of client questions that come in. We were up and running very quickly with Blue J - within 5 minutes, our staff understood how this will be helpful, and the rest of the training program is refining prompting skills and building use cases and best practices."
