If your business requires employees to travel, you’ve likely encountered the choice between paying a per diem or reimbursing actual expenses. Each method has its advantages and disadvantages, and the decision can have a direct impact on your tax situation and administrative workload. Here’s what you need to know about each option.
What is Per Diem?
A per diem is a set daily allowance provided to employees for expenses like meals, lodging, and incidental costs while traveling for business. Rather than submitting receipts for every individual expense, employees receive a flat rate, which varies based on the location of the travel. The IRS provides annual per diem rates, which depend on the city or region.
Benefits of Paying Per Diem
Simplified Record-KeepingWhen you opt to pay per diem, employees don’t need to submit receipts for individual expenses, which reduces the administrative burden on your accounting department.
Predictable CostsSince per diem rates are predetermined, your business can more easily predict travel costs and budget accordingly. This predictability can be especially useful if your employees frequently travel to high-cost areas.
No Taxable Income for EmployeesAs long as the per diem rate doesn’t exceed the IRS-approved limit and employees follow the documentation requirements, the per diem is not considered taxable income for them. This simplifies their tax reporting as well.
Uniform Treatment Across EmployeesPer diem offers standardized reimbursement across all employees, which can ensure fairness and consistency in handling business travel expenses.
Drawbacks of Per Diem
May Not Reflect Actual CostsPer diem rates are fixed, so they may not always match actual expenses. In high-cost areas, employees may feel the per diem is too low, while in lower-cost areas, the per diem might be higher than actual costs, which could result in over-reimbursement.
Must Adhere to IRS GuidelinesTo avoid being treated as taxable income, per diem payments must meet IRS guidelines. These include keeping accurate records of the travel days, locations, and business purposes. If documentation is lacking, it could lead to tax complications for both the business and employees.
What is Actual Expense Reimbursement?
Actual expense reimbursement is when you pay employees based on their documented travel expenses. Employees submit receipts for all travel-related costs—such as meals, hotels, and transportation—and your business reimburses them for the actual amount spent.
Benefits of Reimbursing Actual Expenses
Matches Real CostsThis method ensures that employees are reimbursed based on their actual spending, which can be more equitable in cases where travel expenses vary widely depending on the destination or circumstances. For example, hotel costs in New York City will likely differ from those in a smaller town.
Greater FlexibilityActual expense reimbursement allows employees more flexibility in choosing how they spend their travel allowance. If they find cheaper accommodations or eat less expensive meals, they can control the budget to a greater extent.
Drawbacks of Reimbursing Actual Expenses
More Administrative BurdenEmployees need to save and submit all receipts, and your accounting team must verify each expense, which can significantly increase paperwork. Depending on the volume of travel, this could lead to a time-consuming and inefficient process.
Unpredictable CostsSince expenses are reimbursed based on what employees spend, it can be harder for your business to predict and budget for travel costs. In some cases, employees might spend more than expected, increasing overall expenses.
Taxable Income ConcernsFor the reimbursement to remain tax-free, employees must provide appropriate documentation, including receipts and an accounting of their business-related travel. If proper documentation is not maintained, the reimbursements may be considered taxable income by the IRS.
Which Method is Right for Your Business?
Deciding between per diem and actual expense reimbursement depends on your business's specific needs. If you value simplicity and consistency, per diem may be the best option. However, if fairness and flexibility are more important, especially for high-variation travel, reimbursing actual expenses might be better.
Consider the nature of your employees' travel, the administrative capacity of your team, and your business’s overall tax strategy before making a decision. Both methods have tax benefits, but each has specific documentation and compliance requirements that must be met to avoid tax pitfalls.
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