Can Per Diem Be Taxed? A Breakdown of the Rules

Per diem, a daily allowance provided to employees, covers expenses incurred while traveling for business. The taxability of these payments depends on specific circumstances and adherence to Internal Revenue Service (IRS) rules. Understanding these guidelines helps both employers and employees manage tax obligations effectively.

Understanding Per Diem

Per diem refers to a daily allowance employers provide to cover an employee’s lodging, meals, and incidental expenses when traveling away from their regular place of business. This allowance is distinct from an employee’s regular wages or salary. Its primary purpose is to simplify the reimbursement process for business travel, offering a standardized amount rather than requiring detailed expense tracking for every minor cost.

The per diem rates are often based on established limits set by the federal government, such as those published by the General Services Administration (GSA) for travel within the continental United States (CONUS). These rates can vary significantly by location and are updated annually to reflect current costs for lodging and meals in different areas. Employers can choose to reimburse employees based on these federal rates or their own internal rates, which may or may not align with the federal guidelines.

When Per Diem Is Taxable

Per diem payments become taxable income to an employee under specific conditions, treating them much like regular wages. One primary scenario involves payments made under a “non-accountable plan.” This occurs when the employer does not require the employee to substantiate the expenses with receipts or other documentation, or if the employee is not required to return any excess amounts paid. In such cases, the entire per diem allowance is considered additional compensation and is subject to income tax withholding and payroll taxes.

Another instance where per diem becomes taxable is when the amount paid exceeds the IRS-established per diem rates for the specific location and time of travel. Even if an accountable plan is in place, any amount reimbursed above these federal limits, and not returned by the employee, must be included in the employee’s taxable income. Payments that are not for legitimate business expenses or are provided as a flat amount without a clear business purpose also fall into the taxable category.

When Per Diem Is Not Taxable

Per diem payments are generally not taxable to the employee when they are made under an “accountable plan” that meets specific IRS requirements. An accountable plan ensures that the reimbursements are solely for legitimate business expenses and are properly substantiated. This arrangement allows employees to receive tax-free reimbursement for their work-related travel costs.

To qualify as an accountable plan, three conditions must be met. First, the expenses must have a business connection, meaning they were incurred while the employee was performing services for the employer. This ensures the per diem directly relates to the employee’s job duties and is not a disguised form of compensation. Second, the employee must adequately account for these expenses to the employer within a reasonable period. Third, the employee must return any excess per diem payments to the employer within a reasonable period. If all three conditions are satisfied, the per diem payments are not included in the employee’s gross income.

Reporting Per Diem on Tax Forms

How per diem payments are reported on an employee’s tax documents, specifically Form W-2, depends on whether they are considered taxable or non-taxable. This distinction determines where and how the amounts appear, impacting the employee’s overall taxable income.

For taxable per diem, these amounts are included in Box 1 of Form W-2, labeled “Wages, tips, other compensation.” This means the per diem is combined with the employee’s regular salary and is subject to federal income tax withholding, Social Security, and Medicare taxes.

Conversely, non-taxable per diem payments, which meet all accountable plan requirements, are generally not included in Box 1 of Form W-2. In some instances, non-taxable per diem reimbursements may be reported in Box 12 of Form W-2 with Code L, which signifies “Substantiated employee business expense reimbursements.” This reporting is typically for informational purposes, confirming that the employer processed the reimbursements under an accountable plan.