Per diems can be great for handling business-related expenses but can present taxation issues if not handled properly
You've applied for a job you think you'll really like. The interview has gone well and now you're starting to talk about compensation. The hiring manager throws out the term "per diem." Stop the press; hold the phone; take a step back! What is per diem pay? What does per diem mean? How does per diem work?
In this article, you'll learn that per diem is a monetary amount given to cover expenses - or it can be your actual salary, depending on the role you're applying to.
What is per diem pay?
The term per diem is Latin and means by the day. So, anytime you're offered a per diem, that means you're doing something work-related that is per day. You may have a trip to take, clients to woo, or you may be in a short-term position, like a traveling nurse or substitute teacher.
Per diem pay is either presented as a stipend in addition to your salary, or it can be your actual salary, depending on its intended use. It's always a set amount that the company will pay for a specific thing. Per diem compensation does not, however, replace expense reports.
The federal government requires that expense reports be maintained for tax purposes. It's important to show what the per diem money was spent on and whether it exceeds the federal limits.
How is per diem pay determined?
The federal government has set rates. Specifically, rates are set by the General Services Administration (GSA). Outside of the 48 contiguous US states - Alaska, Hawaii, US territories, and foreign - the rates are set by the Department of Defense.
Generally, when you hear the phrase per diem tossed about, it's because your job will need you to travel or perform extra activities outside of the office - such as taking clients out to dinner. The GSA has a chart that shows your employer, based on your zip code and the fiscal year, how much per diem payments should be for lodging, meals, and incidentals (e.g., tips for service).
For example, if you're in New York, your maximum lodging per diem for the fiscal year 2023 is between $106 and $150, depending on which month you travel. Your maximum meals and incidentals per diem would fall between $60 and $80, again, depending on the month you travel.
The GSA does have a rule for handling expenses in non-standard areas. They generally have higher per diem rates than usual. Ultimately, since 2005, the GSA has based maximum allowances on average daily rates (ADRs), which is a widely accepted lodging industry measure.
If you incur other expenses on your work-related journey, you'd have to negotiate with your employer to have those reimbursed. The GSA doesn't set rates for things like transportation - flights, rental cars, and so on. Be sure to keep receipts and log the expenses.
How to calculate per diem
Several factors must be accounted for when your employer determines the per diem they provide, including the length of the trip and the time of year. Obviously, per diem rates would be affected by peak travel times just like your own pocketbook. Fortunately, the GSAs website makes it easy. Here are the steps:
Visit the GSA Travel Resource page
Choose the destination - you can search by state and city or by zip code
Choose the date of the trip - you can choose the fiscal year (which always starts in October) or enter a date range
You'll be presented with a chart that breaks down the daily rate for lodging and the daily rate for meals and incidentals. So, if you have a six-night trip during the month of February in the fiscal year 2023, you can expect the daily rate for lodging to be $159 and the daily rate for meals and incidentals to be approximately $70. The rate is prorated at 75% for the first and last day of travel. All you do is add everything up to get a total of $1,467.50.
Per diem policies and payments
Of course, just because the GSA indicates that you should get $1,467.50 for your upcoming six-night trip doesn't mean you actually will. Companies can set their own per diem policies to cover expenses.
You may receive a partial payment before your trip and be reimbursed for additional expenses upon return.
Many companies provide credit cards for travel so that employees incur zero out-of-pocket expenses.
Your company might give you the entire amount upfront, with the understanding that if you go over that amount there won't be any reimbursement.
Ultimately, the company is trying to minimize their expenses, no matter which route they take with paying out per diems. If you're the type of person who can handle a 2-star hotel, then your per diem will stretch further. However, if you always want a 5-star hotel, the company doesn't want to bear the expense of your personal preference.
Do you give unused per diem money back?
Now that you've returned from your six-day trip, you notice that you have $113 left over from the $1,467.50 you were given before the trip started. If your employer properly calculated the per diem rate using the GSAs payment tool, you can keep the leftovers. There won't be any tax problems with you keeping what's left, because the per diem rate you received was within federal guidelines and you're turning in a properly executed expense report to account for the money spent.
You won't always get per diem money for trips
There is a generally accepted rule for paying employees per diems. If you are going on a trip that is more than 50 miles away from home, then you can expect per diem money. However, if your trip is only 10 miles away, you should only expect to be reimbursed for expenses - like a meal. Be sure to collect a receipt and indicate on an expense report that the receipt is for a business-related activity.
Per diem pay as a wage
Sometimes employers will offer daily wages for as-needed staff members. This is especially true for some teachers, laborers, healthcare providers, and skilled trades (e.g. crane operators and welders). It seems like per diem workers and contract/freelance workers are in the same category, but there's a difference.
Per diem employee versus contractor/freelancer
A substitute teacher is an employee of the district in which he or she works. A freelancer is not an employee. Per diem employees get W-2 and have taxes automatically withheld from their pay. Freelancers receive a 1099-NEC and have no taxes withheld. This is a key distinction, because if you're hired as a per diem employee, and your employer hands you a 1099, then no taxes were taken out of your pay all year. That can present major tax consequences, because now you're responsible for reporting your income to the IRS and will probably end up with a self-employment tax added to your liabilities.
Pros and cons of per diem work
One of the biggest benefits of being a per diem employee is that you'll have more freedom – a better work/life balance. The company that employs you will often provide training just like they would a full-time employee. Additionally, per diem pay rates are often higher than the rates companies pay full-time staff. Since per diem can be better than per hour rates, it can be a win financially.
On the other hand, per diem work isn't very stable. You could work four days this week and one day next week. Also, while you can refuse to take a shift if you are going to the Bahamas, you won't be paid for that time like a full-time employee with access to vacation days.
Is per diem tax free?
A per diem payment is not considered income by the IRS. Rather, it is a reimbursement for expenses. In this case, since it can be treated as a deduction on your tax return, the money is not taxable. As with anything related to taxes, certain conditions must be met.
If you have a nice boss who decides to give you more money than the GSA says you should get, the extra amount would be taxable.
The absence of an expense report could cause the money to be taxable. The report should indicate what the trip was for, when it happened and where you went, and there should be receipts attached. The IRS uses this information to determine if your expenses exceeded the limits set by the GSA. If they did, the excess might be taxable.
An erroneous tax report could also cause tax problems. The IRS has to be able to clearly see that the per diem payment was for a business-related trip. Again, it's all about that limit set by the GSA. If there's an error on the expense report, or if information is omitted, the employee may have to pay taxes.
When the per diem you receive is your wage, you could have to pay taxes. This, of course, depends on whether you properly completed the W-4 form provided at the start of your employment. It also depends on whether the employer withheld the proper taxes. Your income should be taxed the same way it would be if you were a part- or full-time staff member. If you see that it isn't being done that way, speak with the payroll department as soon as you can.
The bottom line
You should never have to worry about paying business-related expenses out of your own pocket. However, you must have a clear understanding of how per diem rates work to ensure that you don't suffer tax consequences. This holds true whether you're taking a trip for your company or taking on a per diem job role. Take some time to play around on the GSA website to learn more about calculating per diem rates, so that you can talk intelligently about them with your current or prospective employer.
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