Per diem is a method by which employers compensate employees for shelter and meal expenses incurred while working away from home. While the IRS does not specify a distance that would normally trigger eligibility for per diem, other federal agencies use 50 miles as a trigger point for federal employees, a number which has generally been adopted by other employers as well. It is often advantageous for both employers and employees alike to split compensation between salary or wages and per diem, with as much of the compensation as possible split into the per diem column.
Per Diem vs. Salary
Because the IRS considers per diem to be primarily a reimbursement, and not wages per se, per diem income is taxed differently than ordinary income. When employees must document their expenses, for example, the IRS does not charge them income tax. The employer can still deduct the amount paid as an ordinary business expense, however. Moreover, the employer does not have to pay Social Security and Medicare taxes on per diem, as they do with ordinary income, such as a salary or hourly wage.
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Accountable and Non-Accountable Plans
The Internal Revenue Service differentiates between accountable per diem plans and non-accountable plans. An accountable plan is one in which the employee routinely reports expenses to the employer and reimburses the employer for any amounts paid in excess of actual expenses.
Reporting Per Diem
Employers document wages paid on the employee's W-2 each year. Accountable plans, however, only list the amount of per diem paid over and above the employee's reported expenses on the W-2. Otherwise, accountable plans do not need to report wages on a W-2, and the employee does not have to pay taxes on that money. With non-accountable plans, though, the employer includes the full amount of per diem on the W-2 and the income is taxable to the employee, unless the employee files a Form 2106 - Unreimbursed Employee Business Expenses with the Internal Revenue Service.
Meal and Entertainment Expenses
If you have meal and entertainment expenses and you report them on a Form 2106, those expenses are typically only 50 percent deductible. It is to the employee's and employer's advantage to pay for these expenses in an accountable plan, using per diem, because these expenses would be 100 percent deductible to the employer as a business expense, not subject to unemployment, Social Security and Medicare taxes, and also not taxable to the employee.