How Overseas Per Diem Rates Work for Business Travel

An overseas per diem is a daily allowance an organization provides to an employee to cover business-related travel expenses in a foreign country. This method is an alternative to reimbursing actual costs. By providing a fixed daily amount, it reduces the need for extensive receipt tracking for certain costs. This approach streamlines administration and provides employees with a clear understanding of their available funds for daily expenses.

Components of Overseas Per Diem Rates

The total per diem amount is a combination of a lodging allowance and an allowance for Meals and Incidental Expenses (M&IE). The lodging portion is intended to cover the nightly cost of a hotel and is based on the average cost of moderately-priced facilities at the travel destination. The lodging rate includes any mandatory taxes and service charges associated with the room.

The M&IE rate covers a full day’s meals, taxes, and tips, along with incidental expenses. These incidentals encompass costs like laundry, dry cleaning, and tips for service staff such as luggage handlers and hotel maids.

Per diem rates do not cover major travel expenses like airfare, rental cars, or business-related communication costs. These expenses are reimbursed based on their actual cost and require separate documentation.

Locating and Applying Official Rates

The U.S. Department of State’s Office of Allowances establishes the official per diem rates for foreign areas, updating them monthly to reflect current economic conditions. Private employers are not required to use these rates but often do as a benchmark to ensure their reimbursement policies are considered reasonable by the IRS. Travelers can find the current rates using the Department of State’s foreign per diem lookup tool on its website.

To use the tool, one selects the country and city of travel, and the system will display the maximum rates for lodging and M&IE. A specific rule applies to the first and last days of travel, where the traveler receives 75% of the M&IE rate for the location. For example, if the M&IE rate for Paris is $161, a traveler would receive $120.75 for the day they arrive and the day they depart. The full M&IE rate applies to all full days spent at the location, while the lodging allowance is not subject to this proration and can be claimed up to the maximum daily amount.

Tax Treatment for Employees

The tax implications for an employee receiving per diem payments depend on whether the employer’s policy qualifies as an “accountable plan” under IRS rules. An accountable plan must meet three requirements: expenses must have a business connection, they must be substantiated to the employer, and the employee must return any excess reimbursement.

If the per diem reimbursement is equal to or less than the established federal rate, the payments are not considered wages. This means the money is not subject to income tax or payroll taxes and is not reported as income on the employee’s Form W-2. The employee must submit an expense report detailing the time, place, and business purpose of the travel within a reasonable period.

When an employer provides a per diem allowance that exceeds the federal rate, the excess amount is treated differently. The portion of the allowance up to the federal limit remains non-taxable, but the amount paid above that limit is considered taxable income. This excess must be reported as wages on the employee’s Form W-2 and is subject to all applicable income and payroll taxes.

Considerations for Self-Employed Individuals

For self-employed individuals, per diem is a method for calculating tax deductions rather than a reimbursement. These individuals cannot use the per diem lodging rates set by the Department of State. Instead, they must deduct the actual cost of their lodging and retain receipts and other documentation to substantiate these expenses on their tax returns.

However, self-employed individuals can use the federal M&IE rates to calculate their deduction for meal and incidental expenses. This simplifies record-keeping, as it eliminates the need to save every receipt for meals and small tips. The deduction for business meals, even when using the per diem method, is limited to 50% of the standard M&IE rate.

Even when using the M&IE per diem rates, the IRS has documentation requirements. The self-employed individual must maintain records that prove the time, place, and business purpose of the travel. This documentation should include a log showing the dates of departure and return, the destination, and the business activities conducted.