Employers who routinely pay per diem allowances in excess of the federal per diem rates need to track the amount of expense reimbursement allowances paid to employees on a per diem basis, according to guidance issued last week by the Internal Revenue Service (IRS). Generally, amounts employers pay employees to reimburse them for substantiated business expenses are not subject to income or employment tax, however, if employers do not track the allowances and do not require employees to substantiate or repay excess amounts and include excess amounts in the employee’s income and wages, the entire amount of the expense allowance is subject to income and employment tax.
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Revenue Ruling 2006-56 became effective immediately upon being issued. IRS agents have been instructed not to apply the results of the revenue ruling for taxable periods ending on or before December 31, 2006, in order to allow employers to adjust their systems so that excess allowances can be tracked and accurately accounted for. Expense reimbursements for meals and other incidentals associated with business travel that do not exceed the federal per diem rates do not have to be substantiated, under the ruling.
According to the ruling, a per diem allowance arrangement that fails to track excess amounts and does not account for unsubstantiated amounts that are not repaid as part of the employee’s wages, constitutes a pattern of abuse of tax-exempt expense reimbursement rules. Because such arrangements have been determined to be abusive, all expense allowances, not just the excess amounts paid under such an arrangement, are subject to income tax and employment tax.
The federal per diem expense allowance rates for business travel away from home within the continental U.S. between October 1, 2005, and January 1, 2008, are detailed in Publication 1542. Per diem rates for travel within the continental U.S. can also be found on the General Services Administration (GSA) web site under Per Diem. The Department of Defense (DoD) provides per diem rates for both the U.S., including Alaska, Hawaii, and U.S. territories and possessions and foreign destinations. According to the U.S. Department of State (DoS), “Maximum rates of per diem allowances for travel in foreign areas are established by the Secretary of State and apply to all U.S. Government employees and contractors.” Revenue ruling 2006-56 does not appear to directly address the issue of reimbursement of expenses related to travel outside the U.S., but it is probably wise to assume it does. As of press time, the IRS did not respond to inquiries regarding foreign per diem rates.