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.
Based on research of the Internal Revenue Code and Treasury regulations, per diems are
often used in the corporate world to reimburse employees for business-related travel
expenses, including meals and incidental expenses. Per diems provide a simplified way to
calculate and reimburse detailed receipts for each expense.
There are specific rules and limitations regarding the treatment of per diems for meals and
entertainment. The IRS requires that per diems be substantiated with adequate records,
such as receipts or other documentation, to support the business nature of the expenses.
Additionally, the per diem rates cannot exceed the federal per diem rate for the specific
location and travel period.
If the per diems provided to employees meet these requirements and are the prescribed
rates, they are generally not included as taxable income to the employee. This means that
employees do not have to report the per diems as part of their wages and are not subject to
income tax. However, if the per diems exceed the federal per diem rate or are not
adequately substantiated, they may be considered taxable income to the employee.
For employers, the amounts paid for per diems are generally deductible as ordinary and
necessary business expenses under IRC Section 162(a)(2). However, employers need to
maintain adequate records and documentation to support the deductibility of these
expenses as per section 274(d). Failure to meet the substantiation requirements or
exceeding the allowable rates could result in a deduction by the IRS.
Before the Tax Cuts and Jobs Act (TCJA) of 2017, businesses could deduct 50% of meals
and entertainment expenses directly related to trade or business. However, after the TCJA,
the deduction for entertainment expenses was eliminated, and the deduction for meals was
subject to certain limitations and conditions. Currently, the IRC allows deducting 50% of
the cost of meals as long as the expense meets one of the following criteria:
1. The expense is directly related to the active conduct of the taxpayer's trade or business.
2. The expense is incurred while entertaining a client, customer, or business associate and
is associated with the taxpayer's trade or business.
It is important to note that the IRS has provided further guidance regarding what expenses
qualify as deductible meals. Generally, the meal must be provided to a current or potential
contact and should not be lavish.
Furthermore, starting from 2023 onwards, the deduction for meals is subject to a gradual-
out. This means the deduction rate decreases for meals provided to employees on the
employer's premises or through an employer-operated eating facility.
After the TCJA, the deduction for entertainment expenses was eliminated, and the
deduction for meals became subject to new limitations and conditions. The specific
sections of the IRC that pertain to the new rules include Section 274(a)(1) (Disallowance
of certain entertainment, etc., Expenses), 274(n) (Only 50 percent of meal expenses
allowed as a deduction), and Section 274(k) (Business Meals).
What are at least two aspects of the rules that might be misunderstood?
Two aspects of the rules that might be misunderstood are:
1. Substantiation requirements: The IRS requires adequate records and documentation to
support the business nature of expenses claimed under per diems. This includes retaining
receipts or other documentation. Follow these substantiation requirements to avoid the per
diem amounts becoming taxable income to the employee. Employees need to understand
the level of documentation required to be reimbursed for their expenses properly.
2. Exceeding allowable rates: Per diem rates are set by the federal government and vary
depending on the specific location and travel period. If the per diem rates provided to
employees exceed the federal per diem rate, the amount may be considered taxable income
to the employee. Employees and employers must understand and adhere to the allowable
rates to avoid potential tax implications.
Explain how you would advise the client to ensure they understand the rules going
forward.
To ensure a client understands the rules regarding per diems, I would advise the following:
1. Review the IRS guidelines: clients should familiarize themselves with the IRS
guidelines related to per diems. Includes understanding of the substantiation requirements
and the allowable rates for different locations and travel periods. They can access this
information through IRS publications or consult a tax professional specializing in business
expenses.
2. Maintain adequate records. The client must keep detailed records and documentation of
their business-related expenses. This includes retaining receipts or other supporting
documentation for each expense claimed under per diems. By doing so, they can
demonstrate the business nature of the costs and comply with the IRS substantiation
requirements.
3. Stay informed about changes: The IRS may update the per diem rates or develop new
regulations regarding substantiation and deductions. The client should regularly stay
knowledgeable about any changes to ensure they comply with the latest rules. They can
subscribe to IRS updates, consult with a tax professional, or join relevant industry
associations to stay updated on any developments.
4. Consult with a tax professional: If the client finds the rules regarding per diems complex
or wants personalized advice, it is advisable to talk with a tax professional. A tax
professional can provide specific guidance based on the client's unique circumstances and
help them navigate the rules to maximize tax benefits while avoiding potential pitfalls.
Overall, by reviewing the guidelines, maintaining records, staying informed, and seeking
professional advice, the client can ensure they clearly understand the rules per diems and
can effectively comply with the tax regulations.
