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Accountable Plans, Reimbursements and Per-Diem Allowances (Part II) Employers commonly use per-diem and mileage-allowance arrangements to advance or reimburse employee travel expenses. Part II of this two-part article describes and compares different kinds of per-diem and allowance arrangements that can meet accountable-plan substantiation requirements. William J.
Kenny, J.D., CPA
For more information about this article, contact Prof. Kenny at billk@sba.pdx.edu or Dr. Christensen at annec@montana.edu.
Executive Summary
Generally, employers use per-diem allowance arrangements to reimburse employees and independent contractors for business expenses incurred while traveling away from home overnight on business. Mileage allowances are commonly used to advance or reimburse an employee for use of his or her car in pursuit of the employer’s business. There are several types of per-diem and mileage-allowance arrangements available to taxpayers that can potentially reduce recordkeeping for the specific expense amounts covered under the plan. However, employers do not have to use or adopt any such plan; instead, they can base reimbursements on actual expenses and still comply with accountable-plan requirements. Part I of this article, in the July 2003 issue, discussed general rules for reimbursements from accountable plans. Part II, below, examines various types of per-diem travel and mileage allowances commonly in use and how they operate to reimburse or advance workers’ expected business and travel expenses. Federal Per-Diem Arrangements Per-diem allowances may be used for any employee or worker engaged in business travel. They are customarily used to reimburse employees and self-employed (SE) persons who travel for others; they are most commonly used by companies to advance or reimburse employees traveling away from home overnight on business. A per-diem allowance is a payment under an accountable plan that is:
There are many ways to calculate per-diem amounts:
1. The Federal specific locality or regular Federal
per-diem rate method; Basically, use of an acceptable per-diem method and rate satisfies the substantiation requirements for the expense amounts covered by the specified rate. However, each method has other advantages and disadvantages. Exhibit 1 summarizes the pros and cons of the different arrangements discussed below.
Specific-Locality Method The Federal government publishes per-diem amounts for travel by government employees to specific localities around the U.S. and many foreign locations.17 These amounts may be used by employers as company per-diems for substantiation purposes. The amounts for each location within the continental U.S. (CONUS) appear in IRS Pub. 1542, Per Diem Rates (For Travel Within the United States). In many localities, the maximum amount may only be used for part of the year. The 2003 per-diem rate for locations not specifically listed is $55 for lodging and $30 for meals and incidental expenses (M&IE). The rates are generally updated in the fall. Taxpayers then have the option of either increasing the per-diem rate for the fourth quarter or using the prior rates for the entire year. For purposes of the Sec. 274(n) 50% meals expense write-down, the M&IE portion of the Federal per-diem rate is 40%, under Rev. Proc. 2002-63.18
Actual Lodging Expense with Federal M&IE Rate This is a variation of the specific-locality method; it allows employers to reimburse actual lodging costs and pay a per-diem amount for M&IE. The recipient must substantiate the actual lodging expense, but not the M&IE. Incidentals are fees or tips for services (such as porters, baggage carriers and hotel maids). They do not include telephone charges, cab fares or laundry after 2002. This variation is not available to companies that adopt the Federal high-low method. Rev. Proc. 94-7719 and its successors20 permit SE individuals and employees who travel away from home for business to deduct the standard allowance for M&IE.21 However, they can only deduct their actual lodging expenses. For example, in Duncan,22 an SE long-haul truck driver could not deduct his lodging, because he used the Federal per-diem lodging rate and had no records of his actual lodging expenses. In an M&IE per-diem arrangement, the amount of expense deemed substantiated is the lesser of the amount paid or the Federal per-diem rate. A per-diem payment is for M&IE only if the payer:
Much of the case law in this area involves payments to truckers. The courts frequently note that truckers may sleep in the cab of their vehicle, so there can be no assumption on the payer’s part that away-from-home travel necessitates a motel or hotel expense. Whether an employer has a reasonable belief that lodging expenses will be incurred is a question of fact; the focus is on the employer’s expectations, not the driver’s actual expenditures.23 If any of the conditions apply, the per-diem payments will be treated as only for M&IE. In Beech Trucking Co.,24 for example, both long-haul (away-from-home overnight) and short-haul (day trip) truckers were paid 6.5 cents per mile as a per-diem allowance, and were not required to report how they spent the allowance. This mileage reimbursement rate yielded an allowance less than the Federal M&IE per-diem rate. The company applied the 50% meals reduction to 40% of the per-diem amount paid, arguing that the per-diem arrangement with their drivers contemplated lodging expense. Because the company’s per-diem plan was calculated on the same basis as compensation, the 50% limit applied to the entire allowance. The court cited language in Rev. Proc. 96-28,25 Section 4.04, identical to the language in Rev. Proc. 2002-63. High-Low Method This method requires employers to use only two per-diem rates to reimburse employee travel expenses—one for high-cost locations and one for low-cost locations. The Federal government publishes a list of locations within CONUS deemed high-cost localities for part or all of the year. Rev. Proc. 2002-63 provides a list of the cities and applicable dates for high-cost locations for 2003. The per-diem rate for high-cost localities is $204, which includes $45 for meals; the per-diem rate for all other localities is $125, including $35 for meals. The M&IE are broken out only for purposes of the Sec. 274(n) (50%) limit on meals; the high-low method cannot be used as substantiation for an actual lodging expense plan with a standard allowance for M&IE. If this method is adopted, it must be used for all CONUS localities.
Company Per-Diem Arrangements A company may design and adopt its own per-diem plan. However, the plan may not pay advances or reimbursements in excess of expenses “reasonably expected to be incurred.” Regs. Sec. 1.62-2(j), Example 7, illustrates a plan that reimburses employees at 120% of the Federal locality amount and concludes that such a plan is reasonable. However, the employer is required to withhold income taxes and pay employment taxes on the 20% in excess of the Federal-by-locality amount. A company may study the amounts of actual expenses incurred or look to special expense studies, managers’ experience and published government data to satisfy the “reasonably expected to be incurred” requirement.26 However, the IRS will not rule in advance on fixed per-diems that exceed the Federal amounts prescribed in Rev. Proc. 2002-63.
Federal Standard Mileage Allowance The Federal standard mileage allowance is one method of reimbursing employees in lieu of their actual expenses for the business use of their personal automobiles. Under Rev. Proc. 2002-61,27 this rate is 36 cents per business mile driven in 2003. This rate covers expenses such as depreciation, maintenance, repairs, tires, gasoline, oil, insurance and registration fees; it does not include interest, parking fees, tolls and taxes; employees can deduct these amounts separately on Form 2106, Employee Business Expenses, then treat them as miscellaneous itemized deductions subject to the 2%-of-adjusted-gross-income threshold. The standard mileage allowance may not be used by individuals who have depreciated the vehicle using the modified accelerated cost recovery system (MACRS), ACRS, Sec. 179 expensing or any method other than straight-line, in a prior period. However, a taxpayer can switch from the standard mileage allowance to the actual-cost method. When doing so, he or she must reduce the basis in the auto by the depreciation component of the business standard mile-age allowance taken in earlier years, at the rate of 12 cents per mile for 1997, 1998 and 1999; 14 cents per mile for 2000; 15 cents per mile for 2001 and 2002; and 16 cents per mile for 2003. For vehicles acquired after May 5, 2003, and before 2005, for business use, the first-year depreciation limits on luxury automobiles have been increased substantially. Section 201(a) of the Jobs and Growth Tax Relief Reconciliation Act of 2003 increased the Sec. 168(k) maximum allowable first-year depreciation to $10,710. This increase in allowable first-year depreciation makes it more advantageous for some taxpayers to claim actual automobile expenses, rather than the standard mileage allowance.
FAVR Allowances Business-related expenses incurred by an employee in driving his or her owned or leased automobile are deemed substantiated under a qualified plan when the employer reimburses the expenses with a qualifying fixed and variable rate (FAVR) allowance. The FAVR allowance must be based on data derived from the employee’s locality, reflect prices paid by the employee and represent the actual expenses an owner would incur. The fixed component of this allowance (which must be paid at least quarterly) is intended to cover automobile ownership or leasing costs, including depreciation or lease payments, insurance, registration and license fees and personal property taxes. The variable component of the allowance covers operating costs, such as gasoline, oil, tires and routine maintenance or repairs. In constructing a FAVR allowance, the employer must project employee business use of at least 6,250 miles, maximum business use at 75% of total miles and a maximum automobile cost of $26,900. FAVR allowances are subject to stringent eligibility and other requirements, as outlined in Rev. Proc. 2002-61. Non-Federal Standard Mileage Allowances An employer is not limited to Federal allowances. It can use any mileage allowance, as long as it is reasonable (i.e., it does not advance or reimburse amounts in excess of those expenses reasonably anticipated to be incurred). When the employee substantiates the business use of the vehicle, he or she need not substantiate the vehicle cost, because it is substantiated by the allowance. The problem with an allowance in excess of the Federal rate is that the excess is treated as stemming from a nonaccountable plan. Regs. Sec. 1.62-2(j), Example 6, uses that situation to illustrate how a portion of a reimbursement can be regarded as from an accountable plan and the remainder as from a nonaccountable plan.
Problem Areas Industry Custom It is customary in many industries to pay per-diem allowances for travel based on hours worked, miles driven or some other unit of work or compensation. Likewise, it is customary in some industries to pay a flat mileage allowance based on number of customers or service calls made. Generally, these payments are specified in employment agreements, union contracts or are industry practices. A taxpayer’s characterization of a payment as a “per-diem” is not binding on the IRS. Hence, trade union contracts and trucking and transportation industry practices must be examined to determine whether they qualify as accountable plans. If they do not conform to accountable-plan requirements, the amounts paid must be included in wages and are subject to payroll tax withholding. In addition, for travel expenses, employees must substantiate that their travel requires them to be away from home overnight. Failure to do so will result in the employer having to treat the reimbursements as additional wages. Use of Tools Another problem area involves the payments an employer makes to an employee for the use of the employee’s construction tools. For example, in a typical arrangement, an employer pays a welder an hourly wage and a separate hourly “rental” fee for the use of the employee’s welding rig. The Service ruled28 that such an arrangement did not meet accountable-plan requirements, because the employee was not required to substantiate the actual cost of the welding rig; submitting rig tickets reporting hours worked did not satisfy the substantiation requirements. The IRS rejected the application of Rev. Rul. 68-624,29 which allowed an employer to split a payment for the use of an employee’s truck and personal services between wages and bona fide rental fees for tax purposes, reasoning that although the ruling is not obsolete, it was issued prior to the accountable-plan requirements.
Pipeline Construction Rev. Proc. 2002-4130 provides an optional expense substantiation rule for the pipeline construction industry, beginning in 2003. If, as a condition of employment, employees must provide their own welding or mechanics rig, employers may consider paying $13 per hour for rig expenses and an additional $8 per hour for fuel as substantiated, adjusted annually for inflation. In addition, the IRS invites employers in other industries to propose expense substantiation rules for employees required to provide non-personal-use vehicles as a condition of their employment. Conclusion Most per-diem and mileage-allowance plans can reduce recordkeeping requirements for the expense amounts covered by the allowance. However, each has its own advantages and disadvantages from a practical and tax point of view. In addition, employers are not required to formally use and adopt such a plan; they can base reimbursements on actual expenses and still comply with accountable-plan requirements. However, in both cases, the consequences for noncompliance can be severe. Thus, it is helpful to be familiar with the detailed rules and complexities applicable to both straightforward reimbursement arrangements and the most commonly used per-diem and mileage plans. |
