How To Pay Out PTO

PTO payout, also called PTO cash out, means paying out the value of a departing employee’s unused accrued PTO balance or vacation balance. Some states have laws that require employers to pay out PTO for departing employees. Companies may also choose to create policies to pay out PTO voluntarily or to create policies stating that they will not pay out PTO. New trends include PTO conversion programs, PTO purchase programs, and laws banning use-it-or-lose-it PTO policies. 

What Is PTO Payout?

PTO payout is when an employer pays out unused paid time off when an employee departs from the company, either as a voluntary or involuntary separation. The paid time off could be called vacation days or a lump category called PTO. Usually, sick leave is not paid out unless it is part of a combined PTO policy. PTO payout does not apply to unlimited PTO systems since PTO is not earned in an unlimited system.

There is no federal law requiring PTO to be paid out. Some states and local jurisdictions have laws requiring PTO payout. In states where PTO payout is not required by law, employers can voluntarily pay out PTO in accordance with their written policies. 

When To Pay Out PTO

A PTO payout happens during employee separation when required by state law or company policy. This applies to quitting, retirements, layoffs, and firings. There are also additional times when PTO may be paid out, including at the end of the year, throughout the year for companies that offer a PTO conversion plan, or when a company switches to a different PTO system.

PTO Conversion Programs

According to Goldman Sachs Ayco, a growing trend is for employers to offer a PTO conversion program throughout the year. Employees can exchange their unused PTO for a value of their choosing, including applying it to student loan payments, retirement accounts, 529 college savings plans, HSAs, or donations. They may also choose to convert it directly to cash. PTO conversions are taxed at the same rates as PTO payouts, except for contributions to pre-tax funds.

“PTO conversion programs represent a significant shift toward treating benefits as flexible tools for individual well-being rather than rigid corporate policies,” said Ritesh Seth, CEO and Co-founder of Empathy Employer. “By allowing employees to redirect unused time into high-impact areas like 401(k) contributions or student loan repayments, organizations demonstrate a structural empathy that acknowledges and supports the diverse financial realities of their modern workforce.”

Research shows that 83% of employees desire convertible benefits. PTO conversion programs also benefit employers, helping them to reduce costs and decrease employee turnover. If you are considering implementing a PTO conversion program, it is recommended to put a limit on the amount of PTO that can be converted and set additional rules. This way, you can ensure that you are supporting employee wellness and encouraging employees to take time off to relax and recharge. 

PTO Purchase Programs

Another trend is companies offering PTO purchase programs under a cafeteria plan. They are also called PTO buy-sell programs. This gives employees the option to buy and sell a limited number of PTO days on a pre-tax basis. Employers may choose to only permit PTO buying, not selling, or they can set up a plan that allows both.

Like conversion programs, employees enjoy having flexibility and choices with PTO. Employers must carefully navigate complex state laws and IRS regulations when creating a PTO conversion or purchase program.

Use-It-or-Lose-It PTO Policies

Use-it-or-lose-it PTO policies specify that employees will forfeit (lose) their accrued PTO if they do not use it by a specific date, usually at the end of the PTO year. This means that the PTO balance will not carry over into the next year. Some states treat PTO as earned wages that cannot be taken away. In these states, taking away PTO could be classified as wage theft.

Four states ban use-it-or-lose-it policies for vacation time, and some states and cities prohibit them for paid sick leave. California, Colorado, Montana, and Nebraska are the states that ban use-it-or-lose-it policies for vacation time. 

State Laws

Many states do not require employers to pay out PTO, but over 20 states do. Most states do not even require employers to provide vacation time or paid general leave, but if they do, employers must follow PTO laws. Currently, only three states have laws mandating paid leave for any reason: Illinois, Maine, and Nevada. 

If your company policy states that you will pay out PTO, then you must honor that even if your state does not require it. Generally, the laws apply to accrued vacation time that the employee is vested in, not unlimited PTO policies or sick leave. 

Specifics vary among state laws, including when to issue the payout and how long the employee has been at the company. For example, Rhode Island requires employees to be at a company for at least one year in order to receive a payout for vacation leave. It requires paying out vacation leave, but not sick leave, and specifies that the payout should be included in the final paycheck issued on the next regularly scheduled payday. West Virginia requires PTO payout, but permits companies to specify their own requirements and payment schedules.

This helpful chart will quickly tell you if your state requires paid sick leave, requires leave to be carried over, and if PTO must be paid out upon termination. Some states have detailed paid sick leave laws. If you operate a business in multiple states, you need to make sure your policies and practices comply with the laws in each state where employees work.

States That Require PTO Payout

The following states require payout of accrued  PTO or vacation leave when employees depart: California, Colorado, Illinois, Indiana, Louisiana, Maryland, Massachusetts, Minnesota, Montana, Nebraska, New Mexico, New York, North Carolina, North Dakota, Ohio, Rhode Island, South Carolina, Washington D.C., West Virginia, Wisconsin, and Wyoming. Some of these states have additional conditions and exceptions. Employers generally do not pay out unlimited PTO policies, but it is best to consult with a lawyer. 

Exceptions to State Laws

Some states have exceptions to PTO payout laws if the employer has a written company policy stating that they will not pay out PTO and has provided notice of it to new hires. Other exceptions may be based on separation issues or employee tenure. For example, North Dakota requires PTO payout, except if you provided a written policy stating otherwise, if the employee gave less than five days notice, and if the employee worked for you for less than a year. Employers should pay careful attention to the specifics in their state.

How Is PTO Payout Calculated?

The general calculation for a PTO payout is to multiply the total number of unused PTO hours by the employee’s hourly rate. For salaried employees, first calculate their hourly rate by dividing their annual salary by their working hours per year. The number of hours to pay out may vary depending on state laws and your company policies. For example, some company policies put a cap on the number of hours that can be paid out and set conditions for eligibility, such as after a certain period of service. 

PTO payout is considered taxable income. Federal income taxes, Social Security, Medicare, and state and local income taxes apply in accordance with an employee’s regular deductions. If the payout is done as a separate payment that is not part of a paycheck, then the employer should withhold the IRS supplemental wage flat rate of 22% for federal income tax, plus 6.2% for Social Security and 1.45% for Medicare. The PTO payout should be reported on W-2 forms and handled through your payroll service, which can automate the calculations and deductions. 

How To Handle Negative PTO Balances

Some companies permit employees to take leave before they have accrued it, which results in a negative PTO balance. When departing employees have a negative PTO balance, employers may be able to deduct the cash value from the final paycheck. However, some states prohibit deductions from a final paycheck. It is recommended to check state laws and consult with an attorney to create a policy for negative PTO balances. 

Penalties for Noncompliance

If employers fail to pay out PTO when it is required by law or company policy, then they may face wage claims, penalties, fines, litigation, repayment with daily interest, liquidated damages, legal fees, and possibly criminal charges. The consequences and enforcement vary among states, but failing to pay out PTO is an extremely serious matter. Employers need to ensure that they not only pay out PTO when necessary, but they also do so in the specified time frame, which is often as part of the final paycheck. 

Voluntary PTO Payouts

It is recommended that employers meticulously create a written PTO policy that addresses PTO payout in detail and complies with state laws. Many states permit employers to set their own conditions for paying out PTO, including whether PTO will be forfeited at departure. The policy should be included in your employee handbook. Whether an employee handbook is considered a legally binding contract depends on its language and applicable laws. However, employers are expected to honor what they write in their employee handbook, especially with regard to paying out PTO. 

Employers should set the conditions that must be satisfied for payout of accrued PTO at the time of departure. “Some valuable conditions to include are that PTO is NOT paid out at termination for involuntary departures unless state law mandates such, and voluntary departures will have a maximum number of hours of PTO paid out at termination only if ALL the following conditions are satisfied,” said Adam Calli, Founder and Principal Consultant at Arc Human Capital, LLC. Employers should decide upon the maximum and include it in their handbook. 

Here is an example of the conditions to include in a voluntary PTO payout policy. This sample policy was written by Adam Calli based on his human resources expertise. 

Employees must:

1. Have a minimum amount of tenure for their PTO to be paid out. (Anywhere from 90 days to six months is generally reasonable.)
2. Give at least two full weeks (10 business days) of advance notice.
3. Work the two full weeks (10 business days) advance notice period.
4. Provide a written progress/status report on all client and/or company projects currently underway.
5. Provide a written record of passwords, passcodes, and PINs that may be needed to access relevant client or client-vendor systems.
6. Change over Administrator rights for company email accounts, payroll vendor accounts, etc., to another staff member.
7. Provide contact info (name, title, company, email address, and phone numbers) for all parties working on projects. This could include outside vendors, prospects, referral sources, or clients.
8. Assist with the transition of their work to another staff member.
9. Return all company equipment, keys, and files.
10. Complete other factors that may be specific to them.

Upon satisfaction of all of these requirements, PTO time will be paid out at the employee’s base pay rate in their final paycheck. (Adam Calli)

In conclusion, the most critical factors in paying out PTO are adhering to state laws and company policies. By clearly specifying your policies and cautiously following laws, employers can ensure compliance, reduce the risk of disputes, and promote transparency with their employees.