Per Diem vs. Actual Expenses: Which Method Is Better?

When businesses and their employees incur costs while traveling for work, those expenses must be accounted for. Similarly, self-employed individuals must track these costs to claim appropriate deductions. Handling these travel expenses falls under two distinct approaches: paying a fixed daily allowance or reimbursing the exact costs incurred. Each method has its own framework for substantiation and tax reporting, which determines how funds are paid out and how they are treated for tax purposes. Understanding these systems is important for employers and individuals responsible for their own business-related travel.

The Per Diem Method Explained

The per diem method involves providing a fixed daily allowance to cover business travel expenses in place of reimbursing the actual costs an individual spends on a trip. The allowance is designed to cover two main categories: lodging, and a combined category for meals and incidental expenses (M&IE). Incidental expenses are minor costs like fees and tips for service staff, such as luggage handlers and food servers, as well as laundry or dry cleaning services.

The specific dollar amounts for per diem are established by the U.S. General Services Administration (GSA), which publishes standard rates for locations across the continental United States. These rates vary by location to account for differences in the cost of living. As an alternative, employers can use a simplified “high-low” substantiation method. This approach provides a higher rate for travel to designated high-cost localities and a lower rate for all other locations, simplifying calculations.

The Actual Expense Method Explained

The actual expense method requires tracking and substantiating the precise cost of every expense incurred during business travel. Instead of a fixed daily allowance, this approach involves claiming the exact dollar amount spent on each individual item, covering a wide array of potential costs.

Common expenses that can be claimed under this method include:

• The cost of transportation, such as airfare, train tickets, or car rentals.
• Gasoline and tolls if a personal vehicle is used.
• The full price of lodging in a hotel or other accommodation.
• The actual price of meals.
• Tips for services.
• Fees for business-related phone calls and laundry services.

Contrasting Recordkeeping Requirements

The documentation required to substantiate travel expenses differs significantly between the per diem and actual expense methods. For the per diem method, the recordkeeping is less burdensome. An individual must maintain records that prove the business purpose of the trip, the dates of travel, and the destination. If the per diem allowance paid is at or below the established federal rate, receipts for individual lodging or meal expenses are not required, which simplifies the process for the traveler.

Conversely, the actual expense method demands more detailed documentation. Itemized receipts are necessary for all lodging expenses, regardless of the cost. For other individual expenses, the IRS requires a receipt if the cost is $75 or more. A log or diary is also needed to record the specific amount of each expense, the time and date it was incurred, the location, and its direct business purpose.

Tax Treatment Under Accountable Plans

For employees, the tax implications of travel reimbursements are governed by whether the employer’s policy qualifies as an accountable plan. An accountable plan is a reimbursement arrangement that meets three IRS requirements: expenses must have a business connection, they must be adequately substantiated, and any excess reimbursement must be returned by the employee in a reasonable time. When these conditions are met, reimbursements are not considered taxable income to the employee. This holds true whether the employer uses the per diem or actual expense method.

If a reimbursement policy does not meet all the requirements of an accountable plan, it is considered a nonaccountable plan. Under a nonaccountable plan, all reimbursements are treated as taxable wages, included on the employee’s Form W-2, and are subject to income and employment taxes. From the employer’s perspective, payments made under an accountable plan are deductible as a business expense. The employer can still deduct the payments under a nonaccountable plan, but they are classified as compensation rather than a travel expense reimbursement.

Deducting Expenses for the Self-Employed

Self-employed individuals follow different rules, as they take tax deductions for their business travel expenses rather than receiving reimbursements. While they can use the per diem method for meals and incidental expenses (M&IE), they must use the actual expense method for lodging. This means they must keep detailed records and receipts for the cost of their accommodations. Self-employed individuals cannot use the simplified “high-low” method for their M&IE deduction and must use the standard rate for the specific locality of travel.

When calculating the deduction for meals, whether using the per diem M&IE rate or actual costs, the deduction is limited to 50% of the total cost. This limitation is a standard part of the tax code for business-related meal expenses. For the first and last days of business travel, the M&IE per diem allowance is prorated at 75% of the standard rate for the location.