What are the best practices for employers to comply with IRS regulations on per diem payments and avoid large nondeductible addbacks related to meals?

To ensure compliance with IRS regulations on per diem payments and to avoid large nondeductible addbacks related to meals, employers should adhere to the following best practices, grounded in the Internal Revenue Code, Treasury Regulations, and authoritative IRS guidance:

1. Establish and Maintain an Accountable Plan

Requirements for an Accountable Plan:- Business Connection: Reimbursements must be for expenses incurred in the performance of services as an employee and must be deductible under IRC §162 (ordinary and necessary business expenses).- Substantiation: Employees must substantiate the amount, time, place, and business purpose of the expense within a reasonable period. This generally means providing documentation such as itineraries, receipts (for lodging), and expense reports.- Return of Excess: Employees must return any advance or reimbursement in excess of substantiated expenses within a reasonable period (typically 120 days).

**If any of these requirements are not met, the plan is nonaccountable, and all payments are treated as taxable wages, subject to income and employment taxes, and are not deductible by the employer as business expenses.

2. Use IRS-Approved Per Diem Rates

• Federal Per Diem Rates: Use the rates published annually by the General Services Administration (GSA) for lodging, meals, and incidental expenses (M&IE), which vary by location and time of year.
• High-Low Substantiation Method: For simplicity, employers may use the IRS’s high-low substantiation method, which sets a single “high” and “low” per diem rate for designated localities.
• Special Rates for Transportation Industry: If applicable, use the special M&IE rates for transportation workers.

Best Practice: Do not pay per diem rates in excess of the federal rates. If you do, the excess must be treated as taxable wages and is not deductible as a business expense.

3. Apply the 50% Deduction Limitation for Meals

• General Rule: Under IRC §274(n), only 50% of the cost of meals (including the meal portion of per diem allowances) is deductible by the employer.
• Exceptions: The 50% limit does not apply to certain categories, such as meals treated as compensation, meals provided for the convenience of the employer, or meals for certain company events (e.g., holiday parties).
• Temporary 100% Deduction: For expenses paid or incurred after December 31, 2020, and before January 1, 2023, the deduction for restaurant-provided meals was temporarily increased to 100%. This provision has now expired, and the 50% limit applies for 2025.

Best Practice: Ensure that your accounting system applies the 50% limitation to the meal portion of per diem payments, except where a statutory exception applies.

4. Document and Substantiate All Per Diem Payments

• Required Documentation: Even when using per diem rates, employers must collect and retain records showing the time, place, and business purpose of the travel. Lodging receipts are not required if the per diem method is used, but documentation of the trip itself is essential.
• Expense Reports: Require employees to submit timely and complete expense reports, including dates, locations, and business purposes of travel.
• Digital Tools: Consider using digital expense management platforms to streamline documentation and compliance.

5. Prorate Per Diem for Partial Travel Days

• Partial Days: On days of departure and return, per diem should be prorated (commonly at 75% of the daily rate) to reflect reduced meal needs.

6. Return of Excess Reimbursements

• Excess Advances: If an employee receives an advance or per diem for more days than actually traveled, the excess must be returned within a reasonable period (typically 120 days).

7. Written Policy and Communication

• Written Accountable Plan: While not required, a written policy helps ensure consistent application and compliance. The policy should specify:
• Types of reimbursable expenses
• Required documentation
• Deadlines for submission and return of excess
• Maximum allowable per diem rates

8. Special Considerations

• Related Parties: Owners and related parties generally cannot use per diem rates for substantiation and must provide actual receipts.
• Non-Deductible Entertainment: Entertainment expenses are not deductible, and per diem should not be used to reimburse such costs.

9. Regular Review and Training

• Annual Review: Update per diem rates annually to reflect IRS and GSA changes.
• Employee Training: Educate employees on documentation requirements and the importance of timely, accurate reporting.

10. Audit and Internal Controls

• Internal Controls: Implement controls to prevent abuse, such as regular audits of expense reports and per diem claims.

In summary: Employers should use IRS-approved per diem rates, maintain a compliant accountable plan, require proper substantiation, apply the 50% deduction limit to meals, and ensure timely return of excess advances. Written policies, employee training, and strong internal controls are essential to avoid nondeductible addbacks and ensure tax compliance.