A PTO payout tax rate helps employers calculate the tax and understand the financial implications of compensating employees for their unused paid time off.

A PTO encompasses accrued vacation days, sick days, and other approved personal time off. Unused days are typically paid out when an employee retires, leaves the company, or at the end of the year.

In this article, we’ll explore the ins and outs of unused PTO payouts and associated tax implications. We’ll show you how to calculate them for salaried and hourly employees, when to pay them, and how to report, track, and document all of that. Let’s get started!

Key Takeaways

• A PTO payout is recognized by the IRS as a supplemental wage and represents payment for accrued but unused paid time off.
• Many employers use the flat PTO payout tax rate of 22%.
• The taxes for these payouts can also be calculated similarly to regular wages, as they are subject to federal, Social Security, and Medicare taxes.
• PTO payouts can be issued during employment or included in the final paycheck.
• While these payouts aren’t federally mandated, many states have specific laws that govern them.

What Is PTO Payout, and Is It Taxable?

A PTO payout is a lump sum payment to employees who have accrued but haven’t used their paid time off. A PTO refers to paid time off and typically includes vacation, sick, and personal days.

There is no federal law that mandates employers to provide paid time off, but some state laws may require it. Moreover, some companies offer PTO as a benefit to attract and retain talent. If an employer provides PTO and puts it in the worker’s contract, they become legally mandated to adhere to their policies and relevant state laws regarding payouts.

The Internal Revenue Service (IRS) recognizes these payouts as supplemental wages, which means that PTO is taxed. As per Publication 15-A, the standard rate for a federal tax on a PTO payout is 22%. On the other hand, employers can choose to add PTO payout to an employee’s wage, in which case regular wage tax rates and withholding apply.

On top of that, the payouts may be subject to state income taxes, which vary significantly. Some states will tax supplemental wages at federal rates, while others may impose higher rates. That’s why it’s crucial to refer to your state’s rules and regulations to avoid making mistakes and ensure tax and payroll compliance.

Which States Require PTO Payout?

Twenty US states require employers to pay their employees PTO at separation (quitting, retirement, or termination).

The following states require PTO payout for vacation days only:

• California
• Indiana
• Maine
• Massachusetts
• Montana
• New Mexico
• North Carolina
• Illinois
• Maryland
• Minnesota
• Nebraska
• New York
• Rhode Island

Then, there are states that include sick leave in specific instances, in addition to vacation payout:

• District of Columbia
• Ohio
• Louisiana
• North Dakota

Wyoming mandates both vacation and sick leave; West Virginia mandates PTO payouts depending on policy language, while Colorado mandates that all paid leave be included in the payout.

Lastly, sixteen states prohibit “use-it-or-lose-it” policies:

• Arizona
• California
• Colorado
• Connecticut
• District of Columbia
• Maryland
• Massachusetts
• Michigan
• Minnesota
• Montana
• New Jersey
• New Mexico
• New York City
• Oregon
• Rhode Island
• Washington

Most states apply these policies to sick leave only. California includes vacation days, Colorado policies apply to any paid leave, while Montana includes only vacation days.

How to Calculate PTO Payout

To calculate PTO payout, you multiply the employee’s hourly rate by the number of unused hours. Then, you subtract the 22% tax rate to see how much money they will receive in their bank account.

Here are two examples of PTO payout calculations for salaried and hourly employees to help you understand the process better:

PTO Payout for Hourly Employees

Calculating PTO payout for hourly employees is straightforward since you already know their rate. Here is a two-step process:

1. Calculate the gross, pre-tax PTO payout by multiplying the employee’s hourly rate by the number of unused hours.
2. Multiply the pre-tax PTO payout by .78 to account for the 22% flat federal supplemental tax.

The end result will be the amount an employee can expect to receive.

Here is an example of a calculation for an hourly employee who earns $20 per hour and has 30 hours of unused PTO:

• $20 (per hour) * 30 (unused PTO hours) = $600 (gross, pre-tax PTO payout)
• $600 * .78 = $478 (final PTO payout)

PTO Payout for Salaried Employees

To calculate PTO for salaried employees, you must first determine their equivalent hourly rate. Most companies do this by using 2,080 as the number of hours an employee works per year (which stems from multiplying 52 weeks by 40 work hours per week).

Here is an example of a PTO payout calculation for an employee who earns $80,000 per year and has 30 hours of unused PTO:

• $80,000 (annual salary) / 2,080 (annual work hours) = $38.46 (per hour)
• $38.46 (per hour) * 30 (unused PTO hours) = $1,153.8 (gross, pre-tax PTO payout)
• $1,153.8 * .78 = $900 (final PTO payout)

PTO Payout vs Bonus: Are They Taxed the Same?

A PTO payout is taxed similarly to a bonus, commission, or award in the sense that it’s supplemental income. In essence, it’s extra money that employers give to their employees, making it subject to taxation.

The IRS allows employers to use one of the two methods for withholding taxes on PTO payouts:

• The first method is more common and involves using the flat rate of 22% for withholding federal income tax on payouts for up to $1 million. Any payouts exceeding that threshold are taxed at a higher rate of 37%.

• The second method is referred to as the aggregate method, which involves combining an employee’s PTO payout with their wages. This means the employer bundles everything up into a single payment and calculates taxes as if it were a regular wage. This can result in higher initial withholding, but the numbers even out once you file your annual tax return.

Regardless of the chosen method, the actual tax liability doesn’t change. How much tax is withheld from PTO payout depends on your income and tax bracket; any over- or under-withholding will be reconciled after tax filing.

The main difference lies in how this income and taxes will appear on your pay stub, specifically whether they’ll be displayed using the flat rate or the aggregate method.

PTO Payout at Termination vs. During Employment

PTO payouts can happen either during employment or upon termination. Here’s how they compare:

When and How to Cash Out PTO

When and how you should cash out PTO benefits will depend on state regulations, company policies, and personal needs and preferences.

If you are leaving the company, and PTO payouts are included in its policy or mandated by state laws, you will typically receive compensation for unused time in your final paycheck.

However, if you want to cash out your PTO during employment, you will likely have to follow a specific procedure. A common method is to submit a written request to a company’s HR or payroll department. The guidelines and restrictions will be outlined in a policy.

The policies can describe details such as how many hours an employee can cash out at one time or when they can submit requests. Every company will have a different policy, which is why it’s important to follow it and consult with an HR representative in case of any concerns.

Adhering to the policies and familiarizing yourself with relevant regulations will help you cash out your PTO when you need it, without friction.

How to Report and Track PTO Payouts

To report and track PTO payouts, you need to include them in employee pay stubs and Form W-2. Since a PTO payout is taxed and considered a supplemental wage, the reporting requirement is the same regardless of the way it’s issued.

Still, there are some differences in how a PTO payment will appear on your documents based on whether it’s issued as a separate item or with an employee’s wage.

For instance, if the PTO payout is issued with the final paycheck, it should be included in the earnings statement as a separate item. The deductions will then be calculated taking this income into account, typically using the aggregate method.

On the other hand, if a PTO payout is issued as a separate check, it will likely have its own pay stub that will show only the PTO payout as earnings.

When it comes to the Form W-2 boxes, a PTO payout should be included in Box 1: Wages, tips, and other compensation. Additionally, since it’s subject to FICA taxes, it should be included in Box 3: Social Security wages and Box 5: Medicare wages and tips.

Lastly, an employee may be given an option to cash out their PTO payment, which they can save for the next year. The IRS may consider this “constructive receipt,” so the employer may have to pay a PTO tax on the lump sum in the current year. In that case, this income should be included in Box 14: Other, with a relevant description, such as “PTO Payout.”

Report and Document PTO Payouts With Paystub.org

Paystub.org features user-friendly software tools you can use to create professional documentation and report PTO payouts with ease. We offer the following generators:

• Pay stub generator. Create clean and detailed pay stubs with itemized lists. Leverage built-in tools to perform various automatic calculations, like gross and net pay, deductions, taxes, and more.

• Form W-2 generator. Effortlessly generate one or more professional Form W-2s within minutes. File wage and tax statements for all of your employees in a fraction of the time it would take to do it manually.

Apart from these, we also offer an invoice generator and a Form 1099 generator, which are perfect for contractors and small businesses.

Final Thoughts

The key takeaway is that the IRS recognizes a PTO payout as supplemental income, which makes it subject to federal, Social Security, and Medicare taxes, as well as potential state taxes.

While many employers choose the flat 22% tax rate for vacation payout, sick days, and other personal time off, the final tax liability still depends on the employee’s total annual income. Hopefully, all the specific rules and regulations regarding these payouts outlined in this guide will help you get the most out of them while meeting all tax obligations with no costly surprises.

PTO Payout Tax Rate FAQ

#1. Is PTO payout taxed at a higher rate than regular pay?

A PTO payout isn’t necessarily taxed at a higher rate than regular pay, but the rates can be different. Employers can choose to include PTO payouts with wages, in which case standard payroll taxes apply. However, they can pay them out separately and withhold a flat 22% for federal taxes.

#2. Is unused PTO paid out when I quit?

Whether unused PTO is paid out when you quit depends on the laws in your state and your company's policies. Some states mandate PTO payouts for vacation days, sick leave, or all unused hours, while others leave it up to the employer’s discretion to create their own policies.

#3. Can I reduce taxes on PTO payout?

While you can’t reduce the tax rate on a PTO payout, you can reduce your overall tax burden in some instances. For example, you can contribute the funds to a tax-deductible retirement account or use them to pay for medical expenses, which can be deductible.