The Fair Labor Standards Act does not regulate paid time off, which covers vacation and sick or personal leave. As a result, employers must examine whether state law requires it to pay employees for unused time upon separation, as well applicable payment procedures, including rate of pay and due date. If state law does not mandate payout, company policy generally prevails.
Contact your state labor department to determine whether PTO must be paid out when an employee leaves the company. For example, employers in California must pay earned and unused vacation time with final wages, no matter how the employee left the company. The state generally does not regulate payout for sick and personal leave upon separation, only vacation time.
Some states and cities require that employers provide paid sick leave. State law decides whether mandatory sick leave is payable upon separation. For example, when an employee in California leaves the company, her available mandatory sick time can be forfeited and her employer is under no obligation to pay it.
Follow company policy if state law does not mandate PTO payout. For example, if the policy says that employees who resign must give at least two weeks' notice in order to receive vacation payout, employees who do not comply with this requirement are ineligible.
Your PTO policy must be valid and cannot violate state law.
Final Pay Rate
Pay unused time off at the employee's final rate of pay, if required by state law or company policy. Use the earned rate of pay, if state law does not prohibit this practice and you have an established policy telling employees that unused time off will be paid out at the earned rate. For example: an employee earned vacation in the previous year, when her pay rate was $12 per hour. Her rate at the time of separation is $13 an hour. In this case, you may pay the unused vacation at the earned rate of $12 per hour.
The Internal Revenue Service regards lump sum vacation payments upon termination as supplemental wages. The following withholding rules apply:
- If PTO is paid on the same check as the final wages, use the employee's W-4 form and the IRS withholding tax tables to determine federal income tax.
- If payment is made separately from final wages, withhold federal income tax at 25 percent.
Deduct Social Security and Medicare taxes at their respective rates, and consult state law for state withholding procedures for supplemental wages.
Issue the payout on the same check or as a separate check via the method acceptable by state law or company policy. For example, if state law says payment must be made by check or direct deposit, use only those methods. Otherwise, apply company policy. For example, company policy might require that you stop separated employees' direct deposit and issue final and vacation wages via a paper check.
Provide payment by the deadline dictated by state law. For example, the state may require that you pay PTO at the same time that final wages are due, or by the next regularly scheduled payday. The due date for final wages may depend on whether the employee quit or was terminated.
PTO Under One Program
Pay unused accruals if you have one program for paid time off and state law deems vacation payout as mandatory upon termination. For example, say your PTO policy allows employees to take time off for vacation, sick and personal leave or any other reason. Because the employee is entitled to all of her unused PTO time, you cannot separate her available time by paying only vacation days when she leaves the company. She must receive compensation for all unused PTO.
An employer with a practice of paying paid time off, or promises to pay such benefits orally or in writing, may be legally bound to honor the agreement.