In October, the IRS provided an optional method by which employees and self-employed individuals may compute the amounts deemed paid or incurred for business meals and incidental expenses for which they are not reimbursed. Revenue Procedure 2008-59, which was effective Oct. 1, 2008, also updated rules for substantiating employees’ ordinary and necessary business expenses for lodging, meals and incidental expenses incurred while traveling away from home for which they receive a per diem allowance. The Service revised Publication 1542, Per Diem Rates, to reflect the changes. The updated guidance supersedes Revenue Procedure 2007-63.
The procedure also contains substantive updates to the list of “high-cost localities” used in the “high-low” substantiation method and to the deductible percentage of business meals and entertainment expenses of certain transportation industry employees.
Under the “regular federal per diem rate” method, an employer can deduct its employees’ ordinary and necessary business travel, meals and entertainment expenses reimbursed under an accountable plan. Expenses less than or equal to the federal per diem rate should be deducted in an entity’s “Other Deductions” on its tax return. If the expenses exceed the federal per diem rate, the amount up to the rate should be included in an employee’s Form W-2, Box 12 (Code L) and deducted in Other Deductions. However, the amount exceeding the rate should be included in an employee’s Form W-2, Box 1 (and in 3 and 5, if applicable) and deducted as wages subject to income tax withholding and Social Security, Medicare and unemployment taxes. The applicable rates are determined by the locality where the expenses are incurred.
In lieu of using actual expenses in computing the allowable deduction, an employer also has the option of using the “meals and incidental expenses only” portion of the locality’s applicable rate or $3 per day for incidental expenses if no meal expenses are incurred. Self-employed individuals and employees whose expenses are not reimbursed may also use these optional methods in lieu of computing the deduction using actual expenses.
As an alternative to local rates, the “high-low” method simplifies the determination by dividing the continental United States into localities with either of two per diem rates, low cost and high cost. Certain high-cost localities are treated as such only for a portion of the year. An employer must continue to use the method selected for an employee for the entire calendar year, although the employer may elect to update to new rates upon their publication.
Effective Oct. 1, 2008, the high and low rates are $256 and $158, respectively. For purposes of applying the high-low method to the IRC § 274(n) meals and entertainment deduction limitation, $58 of the high-cost rate or $45 of the low-cost rate is treated as paid for meals. The updated rates for the regular per diem method are listed by location in Publication 1542. The standard rate for locations not listed remains at $109, with $39 attributable to meals for purposes of IRC § 274(n).
The following localities have been removed from the high-cost list: Palm Springs and Yosemite National Park, Calif.; Stuart, Fla.; Incline Village, Crystal Bay, Reno and Sparks, Nev.; Conway, N.H.; Providence, R.I.; Loudon County and Virginia Beach, Va.; and Lake Geneva, Wis. Jackson and Pinedale, Wyo., have been added to the high-cost list. The revenue procedure has also revised the portion of the year during which several localities qualify as high cost.
The revenue procedure indicates that the deductible amount of business meals and entertainment expenses incurred away from home by certain transportation industry employees has reached the statutory maximum allowed by the IRC § 274(n)(3) phase-in. For tax years beginning in 2008, the deductible portion of such expenses is 80%. There is currently no provision for a change to this percentage in future tax years.
By Peter R. Matejcak, CPA, student, Loyola University Chicago School of Law.