Table of Contents

Table of Contents

Easier full-service payroll for small businesses

Why must HR professionals understand what a PTO payout is, what laws regulate PTO payouts, when it’s paid out, and how to calculate? Continue reading to find these answers to prepare yourself and your organization.

What Is a PTO Payout?

A PTO or paid time off payout occurs when an employee is paid for their unused paid time off either at the time of termination or during their employment.

Why Is Understanding PTO Payouts Important for HR Professionals?

It’s important for HR professionals to understand PTO payouts so they can create, follow and enforce a clear policy for all employees. Some states also have laws that require PTO and vacation to be paid at the employee’s particular rate.

  • Compliance. Several states require that PTO and vacation be paid to separated employees. In states without a law, it is up to the employer whether or not they pay out PTO. HR plays a key role in determining if their company is impacted by state law. They help create or update policies and procedures to keep their company compliant.
  • Reduce liability. Some state laws define paid time off as acquired vacation time and as wages. This means that if these particular wages are not paid out at the time of separation, an employer could be held liable for unpaid earnings. In fact, some states, such as Massachusetts, have laws which state that an employer could face fines up to $1,000 if concluding income isn’t paid.
  • Consistency. Will your company only pay out PTO when an employee is terminated due to voluntary resignation? What are the conditions that qualify an employee to receive a PTO payout? Whether or not state laws apply to your company, answering these types of questions is important in creating your company’s approach and to help create policies. Following set guidelines consistently and communicating them to your staff will help everyone understand PTO payouts to more effectively handle relevant situations when they arise. It can also be helpful to have employees sign an acknowledgment of their understanding just in case.

Important Laws Regarding PTO Payouts

Even though many employers offer PTO as a benefit, not all state laws require employers to pay it out. For example, several states have laws that require PTO to be paid out upon termination or at the end of the year if PTO wasn’t used. These states include Vermont, Massachusetts, Rhode Island, Connecticut and California.

Law 1: Use It or Lose It Policy Isn’t Applicable

Some state laws prohibit a “use it or lose it policy,” which means employees must be paid their PTO or vacation at the end of the year if they haven’t used it. Some states’ laws, such as California, may allow for an accrual limit, and other states, such as Colorado, require employers to pay out acquired vacation time if an employee retires.

Law 2: Company Policy vs the Law

Even though some states require PTO to be paid out under certain circumstances, there are still methods companies can use to manage this. For example, California employers are not legally required to provide paid or unpaid time off to employees. Therefore they can create their own policies for appropriate use. This means that a company policy could prohibit employees from accruing PTO until they have been employed for 3 months.

Law 3: Taxed Correctly

If your company decides to pay out PTO, it’s important to follow guidelines from the IRS which determine how to tax PTO payouts. Further information regarding this process can be located below in this encyclopedia entry.

When Is PTO Paid Out?

Does a company have to pay out PTO? The answer is that it depends. There are several instances when PTO can be paid out. Companies have the option to provide a PTO payout at the end of the year if employees have not used their PTO. It can also be paid out upon termination and at retirement. Keep in mind that business location is very important in determining all of this. By taking the time to research your state laws to create a policy beforehand, you can save your business a lot of headache in the long run.

Upon Termination

If your company operates in a state that requires payment for unused PTO, be sure to pay an employee all of the PTO they have accrued if they are terminated. Keep in mind that in some states, such as California, if a business’ policy excludes part-time employees from participating in PTO or vacation, you legally don’t have to pay out these employees.

At the End of the Year

If your state has laws which require employers to pay out employees at the end of the year, you must do so to remain compliant. This means a “use it or lose it” policy could be illegal. This is especially important to understand while operating in the state of California.

Retirement

Retirement can also be a particular condition in which state law requires that an employee be paid out. A specific example of this is in the state of Colorado.

How to Calculate PTO Payouts

PTO payouts are subject to the supplemental income flat rate tax of 22%. Fortunately, the IRS provides guidance on how to appropriately tax PTO payouts. Please follow the steps below to calculate PTO payouts correctly.

Step 1: Determine Total PTO Hours

The employee must have accrued PTO in order to cash it out. This needs to be determined to know how much the employee will be paid out. In this example, we will use 30 hours.

Step 2: Calculate Gross Pay

Now that you have determined the number of hours that an employee will be paid out on, we can calculate the gross pay. Let’s assume this particular employee earns $15.00 per hour. We will multiply $15.00 by 30, which equals $450.

Step 3: Withhold Taxes

Now that you’ve calculated your gross pay, you can multiply this number by the federal supplemental tax rate. $450 X 22% = $99. This amount ($99) is how much should be withheld from the PTO payout for federal income taxes.

Easier full-service payroll for small businesses

Reduce payroll errors, stay compliant with complicated laws, and meet deadlines with Eddy Payroll.

Questions You’ve Asked Us About PTO Payout

A PTO payout is considered a lump sum payment according to the IRS, so it is subject to taxation at the supplemental wage tax rate. 

Some companies allow employees to cash out their PTO or vacation so they aren’t pressured to use it by the end of the year. Although a company could create a policy to allow an employee to cash out on PTO whenever they want, it is recommended that the PTO be treated as taxable compensation at the time the employee has the right to cash it out. 

James has worked in the HR field going on 5+ years and currently serves in the role of HR Manager. His areas of expertise are in managing recruiting, onboarding, HR metrics, performance and engagement, employee relations and development. He has earned a masters degree in HR along with the nationally recognized certification of SHRM-CP.

Want to contribute to our HR Encyclopedia?

Posts You Might Like

Easier HR for local businesses

With Eddy’s all-in-one HR Suite you can hire, onboard, manage, and pay employees with one easy-to-use platform. No headache required.

📖 HR Encyclopedia Weekly 🗓

Sign up for weekly insights from the world’s largest HR encyclopedia

Scroll to Top

Submit a Question