Per diems are used by companies to reimburse their employees for daily lodging, meals, and
incidental expenses incurred during business-related travel. However, § 274(d) requires substantiation
requirements to be met: a taxpayer must have a record of the business purpose for the expense, the
dates of the travel, the destination, and amounts spent on each separate expense for lodging, meals,
etc. Furthermore, § 1.274(2)(iii) describes adequate records as receipts, paid bills, or similar evidence
sufficient to support an expenditure. Documentary evidence is required for:
(1) Any expenditure for lodging while traveling away from home, and
(2) Any other expenditure of $75 or more except, for transportation charges, documentary evidence
will not be required if not readily available.
Per diem payments are not part of the employee’s wages if the payment received does not exceed the
expenses paid or incurred by the employee and if the substantiation requirements are met. If the total
allowance received by the employee exceeds expenses paid or incurred by the employee, such excess
must be reported as income on the employee's return (§ 1.274-5(g)).
Taxpayers can use Federal per diem rates to substantiate the cost of business travel—lodging, meals,
and incidental expenses. Publication 1542 provides the rates for all continental U.S. areas. If an
employer uses Federal per diem rates, then the employees are not required to submit receipts for
expenses incurred to the accounting department.
To make sure a taxpayer understands the rules, I would stress that:
Employers must require employees to file an expense report.
The expense report must include the date, time, place, amount, and business purpose of the expense.
If a flat amount is given to the employee, an expense report is still required.
If per diem is paid in excess of the allowable standard federal rate, then the excess is taxable to the
employee.
Per diem, Latin for "per day," is a daily allowance given to employees to cover expenses when
traveling for work. This can include lodging, meals, and incidental expenses. The IRS provides
guidelines for per diem rates under Revenue Procedure 2019-48, which vary based on the location of
travel.
One of the key tax implications of per diems relates to meals and entertainment. Prior to the Tax Cuts
and Jobs Act (TCJA) of 2017, businesses could deduct 50% of meals and entertainment expenses as
per section 274(n)(1). However, the TCJA, under section 274(a)(1)(A), eliminated deductions for
entertainment expenses, while retaining the 50% deduction for business meals.
I believe there are more than a couple of aspects of these rules that might be misunderstood.
However, these are two that I had a bit or trouble understanding, so I’d like to share what I found.
Business Meals vs. Entertainment: There might be confusion about what constitutes a business meal
versus entertainment. Treas. Reg. 1.274-2(b)(1)(i) provides guidance on this, stating that a business
meal is a meal during which business is conducted, and it is 50% deductible. On the other hand,
entertainment is any activity generally considered to provide entertainment, amusement, or
recreation, and it is no longer deductible as per section 274(a)—as explained above. It is important to
distinguish between these two when accounting for expenses.
Actual Cost vs. Per Diem Rates: I believe another potential area of confusion is the choice between
using actual costs or per diem rates for meals. Businesses can choose either method, but once a
method is chosen, it must be used for the entire year as per Treas. Reg. 1.274-5(j)(1). The per diem
rate might not cover all actual meal expenses, but it simplifies recordkeeping.
For the client to understand the rules going forward, I would advise them to keep clear
documentation. Maintain clear records of business meals, including who attended and the business
purpose of the meal, etc. This can help substantiate the deduction if questioned by the IRS as per
Treas. Reg. 1.274-5(j). Also, I would make sure the client understands the distinction between
business meals and entertainment.
Based on research of the Internal Revenue Code and Treasury regulations, explain how per diems are
used in the corporate world and the tax implications regarding meals/entertainment.
b b b b Per diem is an allowance paid to employees for lodging, meals, and incidental costs including tips
and fees incurred when traveling for business. Per Section 162(a) of the IRC, per diem payments are
deductible by employers if such expenses are ordinary and necessary and are paid and incurred
during the taxable year in carrying on any trade or business. Nonetheless, to deduct expenses for
travel away from home in pursuit of business, a taxpayer must substantiate the expenses, as required
by Section 274(d) and in accordance with rules provided by Rev. Proc. 2019-48. Rates for all
continental U.S. areas are provided in Publication 1542. While it is not necessary to submit receipts
for meals and incidental expenses if the federal per diem rate is applied, the lodging receipts are still
required if the per diem for meals only is used. Also, even if the applicable per diem rate is equal to
or less that the federal one, employees still need to furnish the expense reports to substantiate their
expenses. If the expense reports are not submitted to the employers within 60 days or are incomplete
and miss the essential information such as a business purpose, date, and place, or there is no evidence
to support the expense, as required by Section 1.274-5, employees become subject to tax on the full
per diem disbursement. Also, if the reimbursed amounts exceed the federal rates per diem, the excess
is considered taxable wages to employees, otherwise excludable under Section 62(a)(2).
What are at least two aspects of the rules that might be misunderstood?
Prior to amendment by the 2017 Tax Cuts and Jobs Act, TCJA, Section 162(a)(2) permitted a
deduction for business travel expenses including lodging, meals, beverages, and entertainment
expenditures while Section 274(n)(1) limited the deduction for meal, beverage, and business- related
entertainment costs to 50%. There was no requirement to distinguish between meal expenses and
entertainment expenditures for the purpose of the 50 percent limitation. Section 274(d)(1) only
required substantiation for meals and lodging.
Section 13304(a)(1) of the TCJA eliminated the deduction for entertainment expenses while Section
13304(a)(2)(D) amended the 50 percent limitation in 274(n)(1) to remove the reference to
entertainment expenditures. Thus, expenses for entertainment, amusement, or recreation paid or
incurred after December 31, 2017, are no longer deductible as per Section 274(a)(1)(A). Food and
beverage expenses are still subject to the substantiation requirements and the obligation to maintain
books and records under Section 6001. Also, according to Section 274(k) business meals are
deductible only if they are not lavish or extravagant.
b b b Changes to per diem expenses enacted by the TCJA can create confusion among business owners
who might not be informed that entertainment costs are no longer deductible. Consequently, reports
provided by the employees can erroneously include totals for meals, lodging, and entertainment
without separating the costs. Such reports are inadequate, and the reimbursed costs are not illegible to
be deducted by the employers. Also, employees might not be familiar with the rules specified in Rev.
Proc. 2019-48. Unfortunately, incorrect application of the per diem rates can create taxable income if
the reimbursed amount exceeds federally established rates for a given area, as per Section 1.274-5(g),
or if the reports are not properly filled out, submitted on time, and/ or no evidence is provided.
Explain how you would advise the client to ensure they understand the rules going forward.
b b The best option to notify a taxpayer of a tax law change is a short letter stating the fact that there
has been an update to a tax provision. The letter should include a summary of the change, possible
consequences to the taxpayer, and should invite the taxpayer for a quick consultation as face- to- face
conversation allows for a better assessment of client’s comprehension and follow up questions. The
client should be advised that the employees are obligated to provide adequate expense reports even if
employees are paid flat amounts. Also, if the reimbursed costs are paid more than the allowable
federal rate, the difference is taxable to the employee. For bigger companies, I would suggest
utilizing The Compliance Assurance Process (the CAP). It is a great option as it improves federal tax
compliance by employing real-time issue resolution prior to the filing of a tax return (IRS, 2023).
Resources:
IRS. (2023). CAP Memorandum of Understanding.
Rev. Proc. 2019-48
Section 62(a)(2)
Section 274(d)
Section 274(d)(1)
Section 274(k)
Section 274(n)(1)
Section 1.274-5
Section 1.274-5(g)
Section 13304(a)(1)
Section 13304(a)(2)(D)
Section 162(a)
§ 1.274(2)(iii)
§ 1.274-5(g)
§ 274(d)
