Per Diem Nonmeal Expenses Subject to 50% Limitation

By Peter C. Barton and Clayton R. Sager

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IRC section 162(a)(2) allows a deduction for traveling expenses, including meals and lodging while away from home in pursuit of a trade or business. IRC section 274(d) disallows this deduction unless the taxpayer complies with stringent substantiation requirements with respect to the amount, time and place, and business purpose of the expense. Under IRC section 274(n), the deduction for food and beverages is generally limited to 50% of the amount otherwise allowable.

Revenue Procedure 96-64

Several IRS revenue procedures permit certain expense allowances, including per diems, to be treated as satisfying the IRC section 274(d) substantiation requirements for traveling expenses. This elective method does not require employees to submit receipts for their actual expenses. Section 3.01 of Revenue Procedure 96-64 covers two types of per diems paid to employees while traveling away from home on business: one for lodging, meals, and incidental expenses, and the other for meals and incidental expenses (M&IE) only. These per diems cannot exceed the estimated actual expenses, nor can they exceed the applicable federal per diem rate. The amount deemed substantiated is the lesser of the per diem allowance or the federal rate (sections 4.01 and 4.02 of Revenue Procedure 96-64). For the transportation industry, the federal M&IE rate is $36 per day under section 4.04 of Revenue Procedure 96-64.

A per diem is treated as paid for M&IE only if the employer separately pays for lodging, based on receipts submitted by the employee; if lodging is provided by or directly paid for by the employer; if the employee does not incur lodging expenses; or if the per diem is calculated using the same basis as the employee’s wages, such as hours worked, miles driven, or pieces produced.

Section 6.05 of Revenue Procedure 96-64 applies the IRC section 274(n) 50% limitation to per diems. If the per diem is for M&IE only, all of the per diem is treated as for food and beverages, and therefore subject to the 50% limitation. If the per diem also includes lodging, the employer must treat an amount equal to the federal M&IE rate as for food and beverages. If a per diem that includes lodging is paid at less than the federal rate, the employer may elect to treat 40% of the per diem paid as the federal M&IE rate. The remaining 60% would therefore be fully deductible lodging expense. This election permits a deduction of 80% (50% x 40% for the M&IE, plus 60% for the lodging).

Fact Pattern

In Boyd, Continental Express, an S corporation, was a long-haul trucking company, with an average haul of about 1,800 miles. In 1995–1997, Continental employed about 300 drivers, who were on the road an average of 25 to 28 days per month. Most drivers slept in their trucks, except when fatigued or on layover, when they stayed in a motel. Continental paid $25 per day in wages plus $30 per night in motel expense for layover, but not for fatigue. The drivers’ travel expenses included meals, occasional motel rooms, truck parking, showers, laundry, and Federal Express charges.

Continental used the revenue procedures to substantiate deductions for its drivers’ travel expenses. In addition to $0.25 to $0.32 per mile in wages, Continental paid the drivers a per diem of $0.09 per mile (or about $31–$32 per day) for travel expenses, which was less than the drivers’ actual travel expenses. Therefore, except for layovers, the drivers were not required to submit receipts for travel expenses. Continental’s per diem plan was typical of per diems in the trucking industry. Finally, Continental’s accounting system tracked only miles driven, not days worked.

Continental deducted 80% of the per diem payments by treating only 40% as subject to the 50% limitation and deducting the remaining 60% in full. The IRS applied the 50% limitation to all of the per diem payments. Continental argued that the revenue procedures were invalid in requiring all of the per diem to be for M&IE and in applying the 50% limitation to this amount. The IRS’ approach ignored the nature of the expenses actually incurred by the drivers. Continental submitted the testimony of three drivers, who said their average daily nonmeal expenses were $7.61 per day. Continental also claimed that its per diem on miles driven was based on competitive reasons.

The Tax Court’s Ruling

The Tax Court ruled that the revenue procedures are valid and Continental is allowed to deduct only 50% of the total per diem payments. Because Continental’s drivers usually slept in their trucks, the court ruled that Continental did not prove that 60% of the per diem was for lodging. Citing Beech Trucking [118 TC 428 (2002)], the court pointed out that the revenue procedures are elective and allowed Continental to avoid maintaining actual receipts for each expense incurred by its drivers. Even though Continental, unlike Beech, submitted evidence of the average nonmeal expenses not otherwise subject to the IRC section 274(n) 50% limitation, the Tax Court ruled that this evidence was irrelevant, and did not allow an additional deduction. To deduct the nonmeal expense part of the per diem, Continental would be required to substantiate all of the drivers’ actual (not average) travel expenses and not elect the revenue procedures method. Taxpayers cannot pick and choose the best features of both methods to maximize the difference between the deduction and the record-keeping expenses.

‘Rough Justice’

Employers paying employees’ travel expenses have a choice in deducting travel expenses: substantiate actual (not average) expenses, or adopt the revenue procedures method. A combination of the two approaches is not allowed. The revenue procedures method greatly simplifies record keeping, but subjects the entire M&IE per diem to the 50% limitation. The result is “at least rough justice,” the Tax Court noted. For many employers, the cost of substantiating actual travel expenses would exceed the additional taxes incurred from this 50% limitation.

The Taxpayer Relief Act of 1997 gradually increases the IRC section 274(n) deduction for food and beverages from 50% in 1997 to 80% in 2008 for workers in the transportation industry subject to federal hours of IRS rules. The 2004–2005 deduction is 70%. Included are workers in air transportation, interstate trucking, railroads, and the merchant marine. Continental’s drivers would have been included. This change to IRC section 274(n) does not affect workers in other industries and does not eliminate the issue in Boyd for transportation workers. It simply reduces the difference between the deductions under the two methods when the M&IE per diem includes nonmeal expenses.