About 15 years ago, there was a consulting firm going public. Their business was helping clients streamline their operations. As a firm with clients all over the world, one of their larger expenses was travel and entertainment costs. Care to guess how much time was spent pouring over expense reports and keeping the consultants honest? The answer is none! Management's opinion was that if an employee wanted to steal by "padding" their expense report, it would be hard to catch them. Given the relatively small dollars associated with each individual's expense, they did not feel that the amounts found to be improper would justify the expense of searching for them.
What this company did was an extreme example of simplifying a tedious task. It worked for them, but that's not to say it would work in your business. (Still, if you have employees that spend time on the road, there are ways you can easily reduce the time you spend auditing their expense reports and minimize the inevitable conflicts.)
In general, there are two types of arrangements or plans under which you can reimburse your employee(s) - accountable or nonaccountable plan. Under an accountable plan, you require your employee to provide proof for the expenses they claim. Once they meet your substantiation requirements, and those of the IRS, you will be able to deduct 100% of transportation and lodging expenses and 50% of meals and entertainment expenses. The main advantage to an accountable plan is the expense reimbursement is not included on the employee's W-2 as wages. You save payroll taxes and your employee is not burdoned with income that may not be deductible on his or her tax return.
Under a nonaccountable plan, you basically reimburse your employee's expenses without requiring all the substantiation necessary to support a deduction for tax purposes. Payments to an employee under a nonaccountable plan are treated the same as other wages and included on form W-2 at year-end. The advantage of the nonaccountable plan is that your paperwork burden is reduced. The disadvantage of a nonaccountable plan is that you pay payroll taxes on the reimbursements. Depending on the total travel expenses, the payroll tax burden could be substantial.
So how do you reduce paperwork while at the same time minimizing costs associated with out-of-town travel? There is a solution - per diem reimbursements.
The United States General Services Administration periodically calculates and publishes what it considers the normal cost of lodging, meals and incidental expenses for various localities. If you use these rates as your basis for employee reimbursements, the dollar amount of the expense is considered substantiated. Your employee still must explain the time, place and business reason for the expense, but doesn't have to provide receipts.
You have a choice of using the regular federal per diem rate, which is what the government pays its employees when they are on the road, or using the high-low method. Both rates can be found in tables included in IRS Publication 1542. Under the high-low method, you reimburse employees based on the location of their travel. For example, if employee A travels one week to a high-cost location such as Phoenix, Arizona, the per diem for lodging, meals and incidental expenses would be $226 ($58 for meals and incidental expenses). If the city to which the employee travels is not a high cost locality, then you must use the low rate, which is currently $141 ($45 for meals and incidental expenses - M&IE).
It is important to note that you are not required to use either the full daily rate or forego using a per diem reimbursement. In many cases, employers will pay the M&IE per diem while requiring substantiation for the cost of the lodging. This is particularly important when an employee is required to stay at a specific hotel instead of choosing their own. You may also want to pay a per diem rate that exceeds the IRS rates. In this case, if you are under a nonaccountable plan, the excess of your rate over the IRS rates is taxable income to your employee.
Regardless of which per diem method you choose, you must use the same method for your employee throughout the year. You can use different methods for different employees, but each employee's method must remain consistent throughout the year. Also, the rates are revised annually on October 1 to correspond with the federal government's fiscal year.
The use of per diem rates in reimbursing your employees for out-of-pocket travel costs can help you save both time and payroll taxes. This article has discussed only the highlights of the use of these daily allowances. If you reimburse employees for travel expenses, give us a call and let's discuss your options.
Have a terrific September.