Companies that routinely reimburse employees for travel expenses using per diems that are higher than the federal rates, had better make sure the amounts are tracked and documented carefully.
The Internal Revenue Service is going after these unsubstantiated amounts and can impose taxes on the entire per diem. The IRS said payments made from an employer's expense arrangement with no mechanism for tracking allowances paid will be treated as made under a "nonaccountable plan" if per diem allowances are routinely paid in excess of federal rates without substantiation.
The failure to treat the excess allowances as wages for employment tax purposes causes all payments made under the expense allowance arrangement to be treated as made under a nonaccountable plan and, thus, subject to income and employment taxes.
The IRS also stressed the new ruling emphasizes the need for employers to track the amount of expense reimbursements paid on a per diem basis.
A trucking company at the center of the ruling reimburses its drivers for meals and incidental expenses (M&IE) paid or incurred while traveling away from home. The reimbursement is in the form of an allowance for each day the driver is away from home and is calculated as a certain amount of cents-per-mile driven. In the past, the company's industry commonly used this cents-per-mile driven method.
The company establishes the cents-per-mile rate based on its expectation of the amount of daily M&IE that will be paid or incurred and its expectation of the average number of daily miles driven during the month. The company bases its expectations on reliable industry data and on its own data from recent years. Based on the specific methodology and data, the projected allowance is reasonably calculated not to exceed the drivers' anticipated daily M&IE.
Drivers are required to provide logs to substantiate the time, place, and business purpose of the travel away from home for each day (or partial day). However, they are not required to substantiate the amount of actual M&IE. Instead, the company relies on the federal per diem rate, which was $52, the rate in effect during the time in question, which was 2006. Thus, for 2006, $52 or less per day of M&IE paid or incurred by a driver while traveling away from home may be deemed substantiated.
The trouble is, the allowances paid by the company to many of its drivers for M&IE routinely exceed $52 per day.
The company requires its drivers to return any amounts paid to them for M&IE with respect to days they were not away from home on business travel. But drivers are not required to return the portion of the allowance that exceeds the $52 per day.
Neither the policies nor actual practices of the company's expense allowance arrangement include any process for tracking the amount of the cents-per-mile M&IE allowance paid to each driver on a per diem basis. Further, there is no mechanism in place to determine when the allowances exceed the federal rates.
The company does not treat the excess allowances over $52 per day as wages for withholding or employment tax purposes and does not report the excess allowances as wages on the drivers' Forms W-2.
Companies are allowed a tax deduction for amounts paid to employees for certain business expenses. However, the amounts must be paid under an accountable plan, which must require substantiation of expenses. Also, an employee must not be allowed to retain amounts in excess of substantiated expenses.
The IRS concluded the arrangement described in the ruling does not meet the requirements of the accountable plan regulations for per diem allowance arrangements.
The IRS said all payments made under the arrangement are treated as paid under a nonaccountable plan. That means the company must include all amounts paid to reimburse drivers' M&IE—not just excess allowances—in the drivers' wages on Forms W-2 and treat them as wages for purposes of withholding and payment of employment taxes.
While IRS agents were instructed not to enforce this rule before Jan. 1, 2007, if the IRS finds "intentional noncompliance" in payments before January 1, the amounts will be taxed.