Per diems are frequently used by businesses to cover travel expenses for employees.
Unfortunately though, the per diem method can sometimes encourage something we like to call cowboy spending. You know, when an employee leaves on a business trips and goes wild— treating every dinner as an opportunity to take a six-shooter to your profit margin.
Of course, this is a worst case scenario. In this article, we’ll explain just what per diems are and suggest an alternative that’ll make you say “yeehaw!”
What does per diem mean?
Per diem is Latin for “per day.”
Most often, per diem describes a daily allowance provided to employees who travel for business. Per diems cover living expenses such as meals, lodging, and tips.
What are the three uses of per diem?
The term per diem can be used three ways, represented by the following parts of speech:
- Noun: An amount of money provided daily. (This is the most common usage.)
Example: “Company employees are entitled to $60 per diem when traveling in Boston.”
- Adjective: Daily
Example: “Lawmakers are reimbursed for their per diem costs when working away from home.”
- Adverb: For each day
Example: “Substitute teachers typically work per diem and are compensated as such.”
What is a per diem employee?
In this article, we’ll mainly focus on the noun form of per diem. Businesses can also use per diem rates for employment.
For example, when your business needs a temporary worker, you can hire per diem employees to come in on a per day basis. Rather than pay them hourly, you pay them by the day. Per diem workers can be classified as employees or contractors.
How does per diem work?
When an employee travels for business, they inevitably incur some basic living costs. Employers use per diems as a substitute for reimbursements and expense reporting.
When employees travel without per diems, they’re required to keep an exact account of their expenses, with supporting receipts. Then, when they get back to the office, they submit an expense report and wait for reimbursement.
Rather than asking employees to empty their own pockets on a business trip, some employers provide a fixed per diem amount of money to cover meals and other expenses. Employees are still expected to keep an account of receipts or other expense records, but expense reports aren’t as detailed or unwieldy as traditional reimbursements.
Plus, reimbursements are typically processed in exact amounts. Per diems are normally handed out in advance (sometimes in the form of cash or a business credit card) and most companies allow employees to keep any unused per diem money.
What expenses does per diem cover?
Per diem covers the following expenses (as described by the IRS):
- Lodging
- Meals
- Incidental Expenses (including laundry, room service, and tips)
Businesses can pay per diem to cover all three categories, or separate lodging from meals and incidental expenses (M&IE). This is common if the company books the hotel in advance or an employee is staying with family and will not incur any lodging expenses.
Per diem does not include transportation expenses (such as flights, rental cars, taxis, etc). Instead, businesses may choose to make travel arrangements on behalf of their employees or reimburse them for any costs.
Employers who book transportation and lodging in advance will just offer an M&IE per diem to their employees.
What are per diem rates?
Because cost of living varies year-over-year, the IRS releases an annual notice to reflect current per diem rates. Federal per diem rates are in effect from Oct. 1 to Sept. 30 of the following year.
Businesses are not required to offer per diem in place of traditional reimbursement for business travel. Furthermore, employers can choose to compensate per diem at a rate higher or lower than the federal rate. Basically, you can choose any rate you feel is reasonable.
But, if you choose to compensate at a higher rate than the federal standard, the excess amount will be taxable to employees. (Whatever you do, just be consistent.)
Most companies use one of two ways to calculate per diem:
- Standard Rates
- High-Low Substantiation
How do I calculate per diem using the standard rates?
The U.S. General Services Administration website provides a current list of all standard per diem rates by state and locality.
Select the state where your employee will be traveling, and you’ll see the standard rate for that state as well as any localities with significantly different costs.
For example, if your employee travels to Barnhill, Illinois in November, the standard per diem rate for 2020 is $96 for lodging. If they go to Chicago in the same month, the standard per diem rate for lodging is $229.
How do I calculate per diem using the high-low method?
Rather than looking up standard rates for specific cities, some businesses choose to use the high-low method instead.
In their annual per diem bulletin, the IRS includes a list of cities that have significantly higher living costs (for all or part of the year). This list is subject to change but typically includes places like New York City or Washington, D.C.
The 2019–2020 per diem rates list high-cost localities at $297; all other cities within the continental U.S. have a per diem rate of $200. This amount includes both lodging and M&IE.
The rate for meals and incidental expenses only is $71 for high-cost localities and $60 for low-cost localities.
Other per diem rates
Per diem rates for incidental expenses only (which include fees and tips given to baggage carriers, hotel staff, and staff on ships) are $5 per day for any locality.
Additionally, on the first and last days of travel, employers are only required to pay 75% of the standard per diem rate.
The State Department sets per diem rates for any travel outside the U.S.
When is per diem taxable?
Employees don’t have to pay taxes on per diems that are equal to or less than federal rates.
Employees do have to pay taxes on per diems when:
- Per diem amount exceeds federal rates
- Expense reports are not submitted or are incomplete
While expense reporting for per diems is not as comprehensive as traditional expensing, the IRS still requires some standard information: date, location, and business purpose. Employees are required to file reports within 60 days of travel; if they don’t or if reports are incomplete, per diem amounts may be taxable.
Per diems also give employers certain tax benefits. You may be able to deduct per diems as business expenses (as long as you keep good records). Be sure to check with your CPA to verify what you can and can’t deduct.
What are the pros and cons of using per diem?
The per diem method can be a great way to fund travel-related business expenses, but it has its drawbacks.
Advantages of per diem
- A way to simplify your budget: If the finance department knows that each person will only spend $100 per day while traveling on business, they can project anticipated spending. They also won’t sweat reconciling or auditing every expense report.
- Employees have a choice: Most people prefer to choose where they eat, how much they spend, and which hotel they book. If they spend their cash in the first few days, the company doesn’t need to worry about the overspend. If they pinch their pennies and pocket the difference, the company doesn’t spend less but they also don’t overspend.
- Increased spender awareness: Most employees won’t dip into their personal accounts to supplement a lavish dinner. They typically think of per diem as an allowance, which encourages them not to overspend.
- Less paperwork for your business: Record keeping is less of an issue when you simply hand your employee a fixed amount of cash.
Disadvantages of per diem
- Aligning with rates can be complicated: Keeping track of seasonal and geographical rates can be a hassle. Even if you develop several versions of your policy (i.e., urban vs. rural, low-cost vs. high cost cities, domestic vs. international), some locations won’t fit into those neat little boxes.
- Policies require continual updating: A per diem policy isn’t one and done. You could opt for a flat rate per diem year round, but that puts you at risk for over- or under-budgeting.
- Employees can get greedy: Turning an employee into a frugal traveler looks ideal on the surface, but you could create a monster. If they become hyper-focused on saving money to pocket excess cash, they could make decisions that reflect poorly on the company. For example, they could book a hotel room in a sketchy neighborhood (dangerous) or not pick up the check for a client when appropriate (bad for business). Less paperwork for your business
- Client reimbursements muddy the waters: If clients pick up a tab or reimburse for travel, granting an equal per diem to the employee for that day could result in a needless expense for the company.
Are there any alternatives to per diem?
We’re glad you asked. Everyone hates expense reporting, so per diems seem like a good alternative. That is, until you have to calculate per diem rates and make annual policy updates.
A time-saving alternative to per diems is using a financial platform like BILL. With BILL, your employees aren’t expected to use their own money, and you get total control and visibility of spending.
If employees need more money (for canceled flights or last minute client dinners), you can approve requests for additional funds with a single click. And travelers won’t come home with a pile of receipts for your finance team. Instead, they’ll take pictures of receipts using the BILL mobile app, then toss that paper in the trash.
Like per diems, BILL empowers employees to spend smarter by taking away the incentive to overspend.