PTO payout: What happens to PTO when you quit?

PTO (short for: paid time off) is an approach to managing employee leave that combines all of an employee’s leave entitlements in one single PTO package—in contrast to keeping the different types of leave separate. A PTO package can include vacation days, paid days off on public holidays, sick days, and other personal leave entitlements. The big advantage of PTO schemes for employees is that they are free to use their accrued paid time off as they wish.

While PTO schemes mean more flexibility for both employees and employers, they can be difficult to manage with regard to employment termination. Exiting employees often wonder what the rules are for PTO payout when quitting. Meanwhile, employers are often unsure about how to calculate PTO payout and what taxation rules apply. Read on as we dive deep into the ins and outs of cashing out unused PTO when employees quit.

PTO is a system for managing employee leave where the different types of leave (i. e. vacation days, sick days, personal days off, and more) are not distinct but bundled up in a combined leave entitlement employees can use at their own discretion.

It’s a popular employee benefit that is often offered on a “you earn it as you work”-basis. In other words, employees accrue PTO days with each pay period. The question for many employees and employers then is what happens to accrued PTO when an employee decides to quit. The answer is PTO payout.

PTO payout is when an employer cashes out the value of an employee’s unused PTO accruals when he or she leaves the company. The need to financially compensate leaving employees for accrued but unused paid time off can either arise from a legal requirement (i. e. a PTO payout law) or from an internal company policy.

PTO payouts can be quite complex for businesses to handle. The reason for this is simple. The laws surrounding employee termination usually provide guidance on how to pay out unused vacation time when employees leave. However, since PTO not only includes vacation time but also covers sick days as well as other types of leave, employers are often unsure about how much leave accrual they have to cash out.

The general assumption here is that an employee could, in theory, use all his or her PTO for vacation purposes. Under this assumption, all PTO days would basically be considered vacation days, which means that businesses would be required to pay out all the accrued PTO when an employee leaves. But how to actually calculate an employee’s PTO payout?

Different businesses have different PTO policies. While some employers define a set number of PTO days that employees can use throughout the year, others work with a PTO policy under which employees accrue PTO with each pay period. When calculating an employee’s PTO accrual, businesses need to go through different steps:

• Determining the employee’s annual PTO accrual (either in hours or days),

• Dividing the annual PTO accrual by the number of pay periods per year, and

• Multiplying the per-pay-period PTO by the number of pay periods worked and the employee’s pay rate.

Another question that is frequently raised by employers and employees alike is whether PTO payout is taxed or not. If and how PTO payouts are taxed depends on the rules that apply in the respective jurisdiction.

In the United States, for instance, PTO payouts are considered earned wages in most states. The IRS counts PTO payouts as supplemental pay, which means that they are taxed at a flat rate of 22%.

State laws in the United States differ considerably with regard to PTO payout when employees quit. Employers therefore often wonder what states require PTO payout at termination. Here is an overview of the rules that apply in those states where PTO payout is mandatory:

• California: The laws in California define accrued vacation time as wages, which means that employers must pay out unused PTO when an employee quits. If they don't, they are liable for a compensatory payment equal to 30 days of regular wages.

• Colorado: Colorado’s PTO payout rules clearly state that any paid vacation time which has been earned by the employee must be cashed out at the end of the employment relationship. “Use it or lose it”-policies are void under Colorado state laws.

• Illinois: Employers in Illinois are legally required to pay out any unused PTO the employee is entitled to under the terms and conditions of his or her employment agreement—even if the company has put in place a forfeiture clause.

• Louisiana: Louisiana requires employers to pay out unused PTO upon employment termination. However, in some cases, employers might be able to require forfeiture.

• Massachusetts: PTO payout in Massachusetts can be tricky because employers are legally required to cash out unused vacation days but not unused sick days.

In other states, such as Alaska, Arizona, Illinois, Indiana, Kentucky, Maine, and Texas, PTO payout is governed by the rules that are laid out in the company policies or the employee’s individual employment contract.

In cases where there is no legal requirement to cash out accrued PTO and no formal company policy or clause in the employment agreement, businesses typically follow the “use it or lose it”-principle.

While PTO is not a legal requirement under U.S. employment laws, the legal landscape in other countries is vastly different. For instance, most European countries have minimum annual leave requirements employers have to adhere to, plus statutory requirements for sick leave, parental leave, and more.

Since the different types of leave are subject to different laws and rules, managing PTO payout under a combined PTO policy can be difficult. However, there are many countries where the procedures surrounding PTO payout are outlined in the rules that govern severance pay.

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The rules surrounding PTO payout upon employee termination differ from one country to the next. For multinationals with employees in different countries, remaining compliant when managing employee termination, severance pay, and unused PTO cashout can be quite challenging.

In order to avoid compliance issues and fines, global businesses should make sure to fully understand the legal requirements that apply in each country where they have workers. If there are any doubts about how to pay out unused paid time off, it’s best to play it safe and use the services of an Employer of Record (EOR).

An Employer of Record can handle all things employment on your behalf when your business employs workers in countries where you don’t have a legal entity, including PTO payout, severance pay, and employee termination. Book a demo with one of our experts to learn more.