Car Allowances & Per Diem Rate Reimbursements

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Reimbursement Plans

Accountable Plans

Under the most common type of expense plan, employees simply keep track of their expenses, then submit an expense report to their employers detailing their actual costs. The employer reimburses the employee for his or her expenses.

These arrangements require the expenses to have been connected to the employee's services for the employer and also require the employee to account to his or her employer for expenses within a reasonable period of time.

Such arrangements are called accountable plans, and under these plans, employers are not required to include reimbursements to their employees in their employees' Forms W2. Nor do employees deduct the expenses on their tax returns.

Non-accountable Plans

If the plan isn't an accountable plan, the employer includes any expense reimbursements in the employee's taxable wages, and the employee then deducts his or her expenses on Schedule A as miscellaneous itemized deductions.

This arrangement can be problematic for the employee because miscellaneous itemized deductions are deductible only to the extent that they exceed 2 percent of your adjusted gross income. Plus, you can only deduct your itemized deductions if they exceed your standard deduction ($4,850 for singles, $9,700 for married couples). So, for most taxpayers, it's preferable to participate in an accountable plan.

Special Circumstances

Salespersons and certain other types of employees commonly receive car allowances on a periodic basis, often monthly, instead of receiving reimbursements for the actual expenses they occur. How does this work with regard to accountable plans? If a plan isn't considered accountable, the car allowances would be included on the employee's Form W2.

Good news: a car allowance satisfies the IRS' accountability requirements if all of these four conditions apply:

1. Your employer limits payments of expenses (car allowance) to those that are necessary to the conduct of its business, and

2. The allowance isn't more than the federal rate, and

3. You provide accounting to your employer of the dates, places, and business purposes of your expenses within a reasonable amount of time after incurring those expenses, and

4. You aren't related to your employer (or if you are, you're able to prove your expenses to the IRS).

When employees travel away on business, employers often reimburse the employees' business expenses with a fixed payment, called a per diem or an allowance. How these payments are taxed depends upon how your company's per diem rates compare to federal allowance rates issued by the government in IRS Publication 1542.

The federal allowance rate can be figured using any one of these methods:

1. Per diem allowance rates (all rates and methods can be found in Publication 1542, Per Diem Rates):

• The regular federal per diem rate is the highest amount that the federal government pays its employees for lodging, meals, and incidentals while away from home on business. The rates are different depending on the area of travel

• The standard meal allowance rates vary for different areas

• The high-low method of computing the per diem rate

• The standard mileage rate, which is 36 cents per mile for 2003 and 37-1/2 cents per mile for 2004, or

• The fixed or variable rate (under this method, your employer pays you an allowance that includes a combination of a particular cents-per-mile rate plus a flat amount to cover your lease payments or the depreciation on your car)

What happens if your allowance is less than or equal to the federal rate? Will your allowance be included in your W2? No. The allowance won't be included in your W2, nor do you report your expenses on your return (as long as they're less than or equal to your allowance).

But, if your actual expenses were greater than your allowance, fill out Form 2106, Employee Business Expenses, and enter your expenses there. Be sure to show all of your expenses and your allowances (as reimbursements).

However, if the allowance that you receive from your employer is more than the federal rates published in Publication 1542, your employer is required to show the allowance amount up to the federal rate in box 12 of your W2. It's not taxable to you, but it is shown on your W2. The excess that's over the federal allowance will be included in your W2 wages in box 1.

What do you do with your expenses? If your actual expenses are less than the federal rates, you don't do anything: you don't deduct your expenses on your return and you don't put the box 12 amount anywhere on your return.

If your actual expenses are more than the federal rate, you should fill out Form 2106, Employee Business Expenses and show your reimbursements (from box 12 of Form W2) and all of your expenses.

Here's an Example

You travel to Sacramento, California for business and you live in the Midwest. Your lodging expenses were paid for by your employer's credit card, but you had to pay for your own meals. The federal rate for Sacramento for meals and entertainment is $42 per day, but your employer reimbursed you at a rate of $45 per day. You have received an excess of $3 per day.

However, your actual expenses in Sacramento amounted to $49 per day. What do you do? You're out of pocket $4, since you were reimbursed only $45 per day. You have records to prove your expenses and they weren't out of line for the area.

Here's what will happen. Your company will include $3 per day in your W2 wages (box 1) and will show the federal rate amount of $42 per day in box 12 of Form W2 (but not in box 1, taxable wages). The code attached to box 12 will be L to signify that this amount is a substantiated nontaxable employee business expense reimbursement.

You then fill out Form 2106 and attach it to your tax return. You'll show your actual expenses of $49 per day on that form, and you'll enter your reimbursements not included in your income ($42 per day) on Form 2106,. Therefore, your deductible expenses are $7 per day ($49 - $42), before applying the limitation on meals expenses (to 50%). Applying the 50 percent limitation, your deduction of $3.50 per day is an itemized deduction on Schedule A.

It's apparent that this computation can get quite complicated. If you're not sure how your employer computes your car allowance, ask. It's best to know exactly how you're being reimbursed in the event of an inquiry from the IRS.