Does Per Diem Count as Income on Your W-2?

Understanding how per diem payments are treated for tax purposes is important for both employees and employers. These allowances, provided to cover travel-related expenses such as lodging, meals, and incidentals, can impact taxable income and financial planning.

Taxable vs. Non-Taxable Classification

The classification of per diem payments as taxable or non-taxable is determined by IRS guidelines. Per diem payments are generally non-taxable if they adhere to federal per diem rates set by the General Services Administration (GSA) and are used for legitimate business travel expenses. These rates, which vary by location and are updated annually, reflect the cost of living and travel expenses in specific areas. For instance, lodging rates in New York City are higher than in smaller towns due to elevated accommodation costs.

Employers must ensure per diem payments are substantiated through documentation, such as travel itineraries and receipts, to confirm the expenses were business-related. Payments made under an accountable plan, which requires substantiation and the return of excess amounts, are non-taxable. However, payments under a non-accountable plan, where no documentation is required, are subject to income and payroll taxes and must be reported on the employee’s W-2 form.

Employer Requirements on W-2

Employers are responsible for accurately reporting per diem payments on the W-2 form. Taxable per diem payments must be included in the employee’s wages in Box 1 of the W-2. This ensures the IRS receives an accurate account of the employee’s total taxable income.

To determine the taxability of per diem payments, employers must identify whether they fall under an accountable or non-accountable plan. Under an accountable plan, employees substantiate expenses with proper records and return any excess payments, making per diem payments non-taxable and not reportable on the W-2. Conversely, payments under a non-accountable plan are taxable and must be reported. Employers must keep detailed records to support their classification decisions.

When Per Diem Exceeds Standard Rates

When per diem payments exceed the GSA standard rates, the excess portion becomes taxable and must be treated as additional wages included in the employee’s gross income. The GSA rates are benchmarks for typical expenses in specific locations, but actual costs may sometimes surpass these rates.

Employers must ensure payroll systems can differentiate between the non-taxable portion, which aligns with GSA rates, and the taxable excess. Clear communication with employees about how these payments will be reported and their tax implications is essential. Employers may also implement policies requiring prior approval for per diem payments exceeding standard rates to reduce discrepancies and ensure compliance.

If Per Diem Is Misclassified

Misclassification of per diem payments can lead to tax and compliance issues, resulting in financial consequences for both employers and employees. Incorrect classification may expose employees to higher tax liabilities, as the IRS could treat the payments as unreported taxable income. This can trigger penalties under Section 6662 of the Internal Revenue Code, imposing a 20% penalty on underpaid taxes.

Employers who misclassify per diem payments risk scrutiny during audits, which could reveal payroll practices that violate federal regulations. This may result in penalties and interest charges. Adhering to Generally Accepted Accounting Principles (GAAP) and understanding relevant tax codes is critical. Regular internal audits and employee training can help mitigate these risks, ensuring compliance with per diem classification rules.