Per Diem Arrangements and Accountable Plans

By Mark A. Segal

In Brief

Codifying Reasonable Business Practices

Employees and employers can both benefit when a reimbursement for expenses is made pursuant to an accountable plan or through a per diem arrangement. The IRS has been vigilant in challenging arrangements where it suspects the arrangement is merely camouflaging actual compensation in an attempt to avoid taxation. Arrangements that arbitrarily allocate reimbursement and wages, or that are not consistently applied in accordance with typical business practices, will likely not qualify as an accountable plan. Recent case law and IRS pronouncements provide some guidance on how to ensure that an arrangement is structured properly.


Both employers and employees benefit when an employee’s business expenses are reimbursed in conformity with an accountable plan. Employee business expenses reimbursed under an accountable plan can be deducted for an employee’s adjusted gross income. Generally this results in the reimbursement offsetting the expense, so that neither is reflected on the employee’s W-2 form, individual tax return, or withholding. In addition, the reimbursement is exempt from federal, state, FICA, and FUTA taxes.Employers benefit by being able to deduct the reimbursement (note percentage limits on meals and entertainment), while avoiding certain administrative costs and financial matching obligations associated with FICA and FUTA taxes.

In order to be considered reimbursed under an accountable plan:

Per Diem Arrangements and Deemed Substantiation

The IRS is authorized to prescribe rules concerning reimbursement arrangements or per diem allowances for ordinary and necessary business travel expenses. Based on this authority, the IRS may issue rules whereby if such arrangements or allowances are consistent with reasonable business practice, the amount shall be considered substantiated by adequate evidence, and be deemed to satisfy the requirements of an adequate accounting to one’s employer.

Treasury Regulations section 1.62-2(h)(2)(i)(B) provides that if a per diem arrangement satisfies certain conditions, the employee will not be required to return amounts received in excess of actual cost. A number of other recent pronouncements and court cases provide further clarification on what will qualify as an accountable plan.

Revenue Procedure 94-77

Guidance about the treatment of per diem arrangements in Revenue Procedure 94-77 discusses the application of relevant law and regulations (see also Revenue Procedures 2002-63, 2001-47, and 2000-39, discussed below). Regulations section 1.274(d)-1(a) gives the IRS the authority to prescribe rules concerning per diem arrangements for ordinary and necessary business expenses incurred during business travel away from home. This authority enables the IRS Commissioner to set forth rules whereby establishment of a “reasonable business practice” will be considered equivalent to substantiation of the amount of the expense by allowable means.

Satisfaction of these requirements will meet the provisions of IRC section 62 even though the worker is able to retain an excess reimbursement. Such excess, where retained, will technically be includable in income and subject to withholding and taxation, as prescribed by IRC Section 62 and Treasury Regulations section 1.62-2(h)(2)(i)(B)(4).

According to Treasury Regulations section 1.62-2(f)(2), the IRS may set rules governing per diem arrangements whereby the amount of the expense will be treated as satisfying the requisite for accountable plans that excess reimbursements be returned, even though the arrangement does not require the return of such an amount. This is relegated to amounts received for days of business travel that have been substantiated where the allowance is reasonably calculated not to exceed the employee’s expenses.

Per diem amounts are considered to meet the requirements of IRC section 1.62-2(c)(1) when they:
n are paid with respect to ordinary and necessary business expenses incurred (or which the payor reasonably anticipates will be incurred) by an employee for lodging, meals, and incidental expenses for travel away from home in connection with the performance of services as an employee of the employer;

If these criteria are met, the reimbursement will be considered to have been received under an accountable plan. As a result, the amount received will not constitute wages or compensation, and will not be subject to withholding or employment taxes.

The IRS Position

The IRS’ concern over whether reimbursements under a per diem arrangement should be recognized as reimbursement under an accountable plan is evident in a 2001 Field Service Advice (FSA 200132002). The advice addresses modification of fact patterns that the IRS has confronted. The facts concerned a courier service, the drivers of which owned the vehicles used in making deliveries. The drivers were considered employees by the taxpayer and carried out assigned daily routes. It was possible for the drivers to make more deliveries and pickups than were listed on the daily schedule. The taxpayer maintained a chart of the packages delivered and the locations of pickups and deliveries, but no records of actual mileage.

Payments to drivers were categorized as wages (commissions) and rental reimbursement. In part these amounts were calculated based upon reconstructed records, because there were no formal plan or records. The IRS considered the arrangement abusive in that it did not consider actual mileage but instead computed mileage based upon other factors, e.g., rush deliveries and weight of packages. Note that reimbursements made under an abusive arrangement are considered to be made under a nonaccountable plan [IRC section 62(c)].

Recent Case Law

In Shotgun Delivery, Inc., v. United States [85 F.Supp. 2d 962 (N.D. Cal. 2000)], the court granted summary judgment for the IRS. The case involved a courier service that charged customers what was referred to as a tag rate. The tag rate was based upon distance and time involved in delivery, waiting time, and weight. Drivers were compensated with 40% of the tag rate. This amount was paid through two separate checks. One check was labeled for wages and subject to withholding. The other check was labeled reimbursement and not subject to withholding. Because the amount paid for alleged reimbursement did not conform to either actual miles driven or cost incurred, the court found that it did not satisfy the business connection requirement, and it was not considered a reimbursement under an accountable plan.

On appeal, the Ninth Circuit Court of Appeals (88 AFTR2d Par. 2001-5418) affirmed the lower court decision that the amounts paid to drivers should be considered wages. The court reversed the summary judgment with respect to Shotgun’s argument that it reasonably relied on an accountant’s advice as a defense to certain penalties. In the Ninth Circuit’s opinion, this issue should have gone to trial.

Shotgun’s defense was viewed skeptically, because there were no reimbursement-related grounds for the rate and formula used and there was substantial deviation in the rates at which drivers were reimbursed. The court gave the following example:

If two drivers each do one 30-mile delivery (with the same delivery charge), but driver 1 takes one hour while driver 2 takes just 30 minutes, each driver receives the same total compensation (the 40% commission), but driver 1 earns more in taxable wages and less in nontaxable mileage reimbursement than driver 2. In this example the “mileage reimbursement” component of the two drivers’ compensation will differ by $.07 per mile; driver 1 gets paid $4.25 in taxable wages; and driver 2 gets paid $2.13 in wages. Thus, driver 2 gets an additional untaxed $2.12 in his mileage check—and Shotgun pays employment taxes on $2.12 less for him than his peer—although both have driven the same 30 miles.

According to the court, there could be little justification for this difference. Rather, the system was set up in order to enable a greater portion of the amount paid to be classified as reimbursement rather than wages. The court also rejected Shotgun’s argument that reimbursement status should be accorded due to Shotgun being in substantial compliance with the requirements.

In For Trucks, Inc., v. United States [234 F.3d 1340 (11th Cir., 2000)], the Eleventh Circuit reversed and remanded a District Court decision that had been in favor of the IRS with regard to whether a reimbursement arrangement constituted an accountable plan.

The case concerned a trucking company that reimbursed truckers for food, lodging, and incidental expenses using a per diem arrangement based upon “load revenue.” The truckers would turn in daily time logs or report daily hours driven, along with receipts for deliveries and gas purchases. Also submitted were miles driven, routes run, states driven through, and other data (e.g., weather and extent of loading and unloading). The load revenue paid was classified into components of wages and reimbursement of expenses. The reimbursement component was to cover the driver’s food, lodging, and incidentals. Drivers were not required to turn in receipts in order to receive the reimbursement component.

The District Court granted summary judgment in favor of the IRS. The court found that the taxpayer did not meet its burden of proof to establish that the reimbursements were pursuant to an accountable plan. The Eleventh Circuit overturned the decision in light of what it considered to be the critical underlying question of whether Trucks “reasonably anticipated and calculated” the drivers’ expenses prior to issuing reimbursement.

With regard to IRC section 62, one question is whether the expenses allegedly reimbursed were “paid or incurred by the employee in connection with the performance of services as an employee of the employer.” The Eleventh Circuit took issue with the District Court, which had found this lacking due to the potential for reimbursement regardless of whether the trucker actually incurred lodging costs. According to the Eleventh Circuit, Revenue Procedure 90-60, 1990-2 C.B. 651, provides that this element will be satisfied where the alleged reimbursement (allowance) is paid on any basis that is consistently applied and in accordance with reasonable business practice. Here, Trucks alleged that its manner of reimbursement was based on research and standard business practices in the industry.

Employees are required to substantiate each business expense to their employer within a reasonable time. A major exception applies where there is a per diem arrangement based upon reasonably expected expenses and this per diem is less than the allowable federal rate. Whether the arrangement is reasonable may be a matter for a jury to determine.

Amounts paid in excess of expenses substantiated must be returned to the employer within a reasonable time. In the case of a per diem arrangement, this criteria is considered satisfied when the rate for each day or mile traveled is reasonably calculated not to exceed the actual expenditure, and any excess is to be returned within a reasonable time.

Other relevant decisions include Trans-Box Systems, Inc., v. United States [84 AFTR2d 6479 (N.D. Cal. 1998)] and Worldwide Labor Support of Mississippi, Inc., v. United States [312 F.3d 712 (Fifth Cir., 2002), vacating and rem’g 2001-2 U.S.T.C. P50,463 (S.D. Miss. 2001)].

UAL

Another case which merits discussion is United Air Lines, Inc., v. United States [88 AFTR2d Par. 2001-5178 (U.S. Ct. of Fed. Cl.s, 2001)]. In UAL, the Claims Court ruled that amounts paid by United Airlines under a purported per diem arrangement were not subject to either FICA or FUTA obligations. In a related case, the Tax Court had ruled that such arrangement constituted deductible compensation paid by United, due to a valid employer-employee relationship, and the need to pay such amount to secure personnel and remain competitive. The court rejected the IRS’ claims that the arrangement did not constitute bona fide compensation eligible for deduction.

The arrangement challenged by the IRS in these cases was based upon a collective bargaining agreement. The agreement provided an amount to be paid pilots and flight attendants for on-duty hours. The amount was to reimburse flight crews for “expenses incurred during both day and overnight travel.” Travel status was determined for this purpose based upon time on duty away from the worker’s home base. The IRS contended that a portion of the alleged per diem should be treated as wages for purposes of FICA and FUTA taxes.

It was noted that an exception to FICA and FUTA taxes exists for amounts received for travel expenses [Treasury Regulations sections 31.3401(a)-1(b)(2) and 31.3121(a)-1(h)]. The exception requires that the amounts be paid specifically for travel and other expenses incurred or reasonably expected to be incurred by the employee while on company business and that the expense payments be identified specifically at the time of payment.

The parties stipulated that the second of these requirements was met. The taxpayer then bore the burden of establishing that the workers receiving the alleged per diem amount were reasonably expected to incur such cost in an amount equal to or greater than the amount reimbursed.

The amounts provided under the per diem were derived from management experience in traveling, data collection (e.g., hotel menus), a consultant’s study of such costs, and testimony from workers on the typical daily routine. A witness for the taxpayer admitted that in part the arrangement was based on boosting morale, and the need to offer a competitive compensation package.

Based upon the evidence, the court found that meal allowances were grounded on an objective and valid basis and as such were not subject to withholding and deduction of FICA and FUTA taxes. Note that in American Airlines, Inc., v. United States [40 Fed. Cl. 712 (1998), aff’d in part, rev’d in part, and remanded, 204 F.3d 1103 (Fed. Cir. 2000)], a similar result was reached.

Revenue Procedure 2002-63

Two recent revenue procedures relevant to accountable plans and per diem arrangements are: Revenue Procedure 2002-63, regarding applicable situations arising on or after October 1, 2002, and before November 1, 2003; and Revenue Procedure 2003-80, regarding applicable situations arising on or after November 1, 2003.

Revenue Procedure 2002-63 notes that the IRS has the authority to set forth rules pertaining to when reimbursement plans and per diem arrangements satisfy tax requisites for deduction purposes. This rule-making authority includes judging when adequate substantiation has been made of a travel expense for tax purposes, so as to be considered an adequate accounting to the worker’s employer. Noted is the fact that the worker must return any excess amount received from the employer as reimbursement. The IRS has the authority to consider such a requirement satisfied in the case of a per diem allowance even though the worker retains such excess.

Revenue Procedure 2002-63 indicates that the manner of determining such a per diem amount may be affected by the geographic area in which the expenses were incurred. Of note is the definition of “incidental expenses” incurred in business travel:

Special rules are set forth concerning transportation expense, including utilization of the high-low method of reimbursement and special rules concerning meal and lodging costs.

Revenue Procedure 2003-80

Recently, Revenue Procedure 2003-80, 2003-45 IRB 1, was issued. It supersedes, except to the extent otherwise specified, Revenue Procedure 2002-63 with respect to “per diem allowances that are paid both (1) to an employee on or after November 1, 2003, and (2) with respect to lodging, meal, and incidental expenses or with respect to meal and incidental expenses paid or incurred for travel away from home on or after November 1, 2003.”

According to its express purpose, Revenue Procedure 2003-80 updates Revenue Procedure 2002-63 concerning deemed substantiation of “the amount of ordinary and necessary business expenses of an employee for lodging, meal and incidental expenses or for meal and incidental expenses incurred while traveling away from home will be deemed substantiated under Section 1.274-5 of the Income Tax Regulations when a payor (the employer, its agent, or a third party) provides a per diem allowance under a reimbursement or other expense allowance arrangement to pay for the expenses.” Revenue Procedure 2003-80 provides certain optional methods which may be relevant depending upon qualification, as well as certain means of computing the allowable deduction for meal and incidental expenses for an employee and self-employed individual for travel away from home. Note that Revenue Procedure 2003-80 sets forth certain special rules concerning the transportation industry, as does Revenue Procedure 2002-63.


Mark A. Segal, LLM, CPA, is a professor of accounting at the University of South Alabama, Mobile, Ala.


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