When Is Per Diem Considered a Fringe Benefit?

Whether a per diem payment is a taxable fringe benefit depends on how an employer structures the reimbursement. A per diem is a fixed daily allowance an employer provides to an employee to cover lodging, meals, and incidental expenses incurred while traveling for business. If the payment system follows specific Internal Revenue Service (IRS) guidelines, the money is not taxable income to the employee. However, if the arrangement fails to meet these standards, the entire per diem amount becomes taxable wages.

Fringe Benefits and General Taxability

A fringe benefit is a form of compensation provided to an employee for the performance of services, separate from their stated salary. The IRS presumes any fringe benefit is taxable income unless a specific exclusion in the tax code applies. This means the value of the benefit must be included in an employee’s earnings and is subject to federal income tax withholding, as well as Social Security and Medicare (FICA) taxes.

This rule covers a wide array of perks. For instance, if a company provides an employee with a vehicle that is used for personal commuting, the value of that personal use is a taxable fringe benefit. This framework explains why per diem can be taxable, placing the burden on the employer to prove their plan qualifies for an exclusion.

The Accountable Plan Exception for Per Diem

Since the Tax Cuts and Jobs Act of 2017 suspended deductions for unreimbursed business expenses, an accountable plan is the only way for an employee to receive tax-free compensation for business travel costs. An accountable plan is a reimbursement arrangement that meets three specific tests to demonstrate that payments are legitimate business expense reimbursements rather than disguised compensation. If a plan meets these conditions, per diem payments up to the federal rates are excluded from an employee’s gross income.

First, a business connection must exist, meaning the employee incurred the expenses while performing services for the employer. The travel must be for legitimate business purposes, like meeting clients or attending conferences. Per diem cannot cover personal travel expenses, even if they occur during a business trip.

Second, employees must substantiate their expenses to the employer within a reasonable period, such as 60 days. This requires documenting the amount, time, place, and business purpose of the travel. For per diem, a travel log or expense report showing the dates and location of the trip is sufficient.

Third, the employee must return any per diem allowance that exceeds their substantiated expenses within a reasonable period, such as 120 days. For instance, if an employee receives a five-day advance but the trip only lasts three days, they must return the per diem for the unused two days. This rule ensures payments are for actual business travel and not tax-free bonuses.

Consequences of a Nonaccountable Plan

When a reimbursement arrangement fails to meet any one of the three required conditions, it is classified as a nonaccountable plan. All payments made under a nonaccountable plan are considered taxable wages.

For example, if an employer provides a flat monthly travel allowance without requiring employees to substantiate their travel or return any unused amounts, the plan is nonaccountable. The employer must include these payments in the employee’s gross income and withhold federal income, Social Security, and Medicare taxes. The employer is also responsible for paying its share of these payroll taxes.

This reclassification has financial implications for both parties. The employee receives a lower net payment due to tax withholdings. The employer faces an additional tax liability and administrative burden, and failure to comply can lead to penalties for incorrect tax reporting and failure to deposit payroll taxes.

Reporting and Record-Keeping Requirements

The distinction between accountable and nonaccountable plans impacts how per diem is reported on an employee’s annual Form W-2, Wage and Tax Statement. Payments under an accountable plan are not reported on the W-2 because they are not considered wages. If a per diem payment exceeds the federal rates, the excess portion must be reported as wages.

In contrast, all payments from a nonaccountable plan must be included in the employee’s taxable wages in Box 1 of the Form W-2. These amounts are also included in Box 3 for Social Security and Box 5 for Medicare wages.

To support the tax-free treatment of per diem, employers must maintain records proving the business connection and substantiation for all reimbursed expenses. This documentation includes employee expense reports, travel logs, and the company’s written policy. Employees should also retain copies of their records in case of an audit.