How a PTO Cash In Works and How It’s Taxed
Understand the financial mechanics of a PTO cash-out, from determining its gross value to the tax rules that impact your final payment.
A Paid Time Off (PTO) cash-in allows an employee to receive monetary compensation for their unused vacation or leave hours instead of taking the time away from work. This process converts accrued time off directly into wages. It can happen under two general circumstances: as a lump-sum payment when an employee separates from the company, or through a voluntary program offered to current employees.
PTO Payout Entitlement
Whether an employee is entitled to a PTO payout depends entirely on specific state-level regulations and the employer’s own established policies, as there is no single federal law that mandates the payout of accrued time off. When an employee quits, is laid off, or is otherwise terminated, the requirement to pay out unused vacation time varies significantly. Some states have enacted laws that treat accrued vacation as earned wages, which must be paid to the employee upon separation. In many other states, there is no such legal requirement, and the matter is left to the employer’s discretion, making the company’s official, written policy the definitive rule.
Separate from termination, some companies offer voluntary PTO cash-in or conversion programs as a benefit to current employees. These programs are entirely at the discretion of the employer and are not mandated by any law. They allow employees to sell back a portion of their accrued time off to the company for cash.
A policy might limit the number of PTO hours an employee can cash out each year or require that a minimum balance of PTO hours be maintained after the cash-out. Often, these transactions are restricted to specific windows, such as during an annual open enrollment period.
Calculating the Cash Value of Your PTO
Determining the gross value of a PTO payout is a process that begins with identifying the employee’s correct rate of pay. The payout is based on the employee’s base rate of pay at the time the cash-in occurs. This means that other forms of compensation, such as overtime premiums, commissions, tips, or performance bonuses, are typically not included in the hourly rate used for the PTO calculation. The controlling factor is almost always the standard, non-overtime wage rate.
For salaried employees, an extra step is required to find their equivalent hourly rate. This is commonly done by dividing the total annual salary by 2080, which is the standard number of work hours in a year (40 hours per week multiplied by 52 weeks). For example, an employee with an annual salary of $62,400 would have an equivalent hourly rate of $30 ($62,400 ÷ 2080).
The formula is the employee’s hourly rate of pay multiplied by the number of PTO hours being cashed out. Using the previous example, if the employee with a $30 hourly rate cashes out 40 hours of unused PTO, their gross payout amount would be $1,200 ($30 x 40).
Tax Implications of a PTO Payout
A PTO payout is not taxed in the same way as a regular paycheck. The Internal Revenue Service (IRS) classifies these payments as “supplemental wages,” which means specific tax withholding rules apply.
Employers use one of two methods to withhold federal income tax from supplemental wages. The first is the percentage method, where the employer withholds a flat 22% from the gross payout for federal income tax for supplemental income up to $1 million in a year. This method is common because it is simple to administer.
The second option is the aggregate method. With this approach, the employer combines the PTO payout with the employee’s regular wages for the current pay period and calculates the federal income tax withholding on the total amount as if it were a single, large payment. This can result in a higher withholding amount for that specific paycheck, as the combined income may temporarily push the employee into a higher marginal tax bracket. The amount of tax withheld will be trued up when the employee files their annual tax return.
In addition to federal income tax, PTO payouts are subject to the same FICA taxes as regular wages. This includes a 6.2% tax for Social Security on earnings up to the 2025 annual limit of $176,100, and a 1.45% tax for Medicare, which has no wage limit.
State and local income taxes are also withheld from PTO payouts in jurisdictions that have them. To illustrate the impact of these taxes, consider the $1,200 gross payout from the previous section. Using the 22% flat rate, the federal income tax withholding would be $264 ($1,200 x 0.22). FICA taxes would amount to $91.80 ($1,200 x 0.0765). The resulting payment, before any state or local taxes, would be $844.20.