Vacation Payout Tax Rate in California: What You Need to Know

Unused vacation time can sometimes be cashed out when leaving a job or under specific company policies. However, many people are caught off guard by the taxes withheld from these payouts, especially in California, where tax rules can be complex. Understanding how much will be deducted and why can help you plan accordingly.

California categorizes vacation payouts as supplemental wages, which affects how they are taxed and reported. Knowing the applicable withholding rates and potential tax implications ensures there are no surprises when receiving your payout.

Classification as Supplemental Wages

Vacation payouts are considered supplemental wages rather than regular earnings, resulting in different withholding rules that often lead to higher upfront tax deductions. The state follows federal guidelines, which also classify bonuses, commissions, overtime pay, and severance as supplemental wages.

Since vacation payouts are not tied to a specific pay period’s work, employers must follow specific withholding methods outlined by federal and state tax authorities. The IRS provides guidance under Publication 15 (Circular E), which California generally aligns with, though the state has its own requirements.

The method of taxation depends on how the payout is issued. If included in a normal paycheck, it may be taxed differently than if issued separately, affecting the amount withheld.

State Withholding Rate

California requires employers to withhold state income tax on vacation payouts using specific methods based on how the payment is issued.

Flat-Rate Withholding

When issued separately from regular wages, California mandates a flat withholding rate. As of 2024, the state requires a 10.23% withholding rate on supplemental wages, including vacation payouts. For example, a $5,000 vacation payout results in $511.50 withheld for state income tax.

This method simplifies tax calculations but can result in higher upfront withholding compared to an employee’s usual tax rate. If the flat rate exceeds the actual tax liability, the employee may receive a refund when filing their state tax return. Conversely, if the flat rate is lower than the final tax obligation, additional taxes may be due. Employees should review their total income and withholding amounts to determine if adjustments, such as estimated tax payments, are necessary.

Percentage Method

If a vacation payout is combined with regular wages in the same paycheck, a different approach applies. Instead of the flat rate, withholding is based on total taxable wages for the pay period. The state’s progressive income tax brackets determine the applicable rate, meaning the vacation payout could temporarily push an employee into a higher withholding bracket.

For example, if an employee typically earns $4,000 per pay period and receives a $3,000 vacation payout in the same check, the total taxable wages for that period would be $7,000. The employer would then use California’s withholding tables to determine the appropriate tax rate based on the employee’s filing status and allowances.

Since this method considers total earnings, the actual tax impact depends on the employee’s overall income for the year. If too much is withheld, a refund may be issued when filing a return. Employees expecting a significant payout should review their withholding allowances to avoid unexpected tax liabilities.

Combined Bracket Method

Some employers apply standard California income tax rates to total earnings, including the vacation payout.

California’s income tax rates range from 1% to 13.3% in 2024, depending on taxable income. If a vacation payout increases total earnings for the pay period, it may temporarily push an employee into a higher bracket. For instance, an employee earning $50,000 annually who receives a $10,000 vacation payout may see a portion of their earnings taxed at a higher rate.

Employers using this method refer to California withholding schedules to determine the correct amount to withhold. While this approach may result in higher withholding in the short term, any excess can be refunded when filing a state tax return, depending on total annual income and deductions.

Additional State Taxes

Beyond income tax withholding, vacation payouts in California can be subject to other state-level deductions.

State Disability Insurance (SDI) applies to most wages earned in the state. As of 2024, California requires SDI contributions at a rate of 1.1% on earnings up to $153,164. Since vacation payouts are taxable wages for SDI purposes, employees who have not yet reached this income cap will see an additional deduction.

Unemployment Insurance (UI) and Employment Training Tax (ETT) are employer-paid obligations, meaning they do not directly affect an employee’s payout. However, vacation payouts must be included in quarterly UI wage reporting, which can impact an employer’s UI tax rate.

California also enforces wage garnishments for obligations such as unpaid child support, tax debts, and court-ordered payments. If an employee has outstanding liabilities subject to garnishment, a portion of their vacation payout may be withheld. The amount depends on the type of debt and California’s garnishment limits. For example, child support garnishments typically cap withholding at 50% to 65% of disposable income. Employees with existing garnishments should verify with their employer or payroll provider how their vacation payout will be affected.

Local Variations

California’s state tax laws create a baseline for vacation payout taxation, but local jurisdictions can introduce additional complexities.

Some cities and counties impose unique payroll taxes on supplemental wages. For example, San Francisco levies a Payroll Expense Tax on businesses with more than $2 million in annual payroll, affecting how companies allocate costs, including vacation payouts. While this tax is employer-paid, it can influence compensation policies, particularly for high-earning employees or those receiving large lump-sum payouts.

Los Angeles and Oakland enforce local minimum wage ordinances that indirectly impact vacation payouts. Since vacation accrual is often tied to an employee’s base hourly rate, higher local wage floors can lead to larger accumulated balances, resulting in more substantial payouts when cashed out. Employers operating in multiple jurisdictions must ensure compliance with local wage laws, as failure to adhere to accrual and payout requirements can result in penalties. The City of San Diego, for instance, mandates that unused vacation be paid out upon separation, reinforcing the importance of accurate record-keeping.

Reporting on Your Tax Return

Vacation payouts are taxable income and must be reported on both federal and California state tax returns.

Employers include vacation payouts in an employee’s Form W-2. The amount withheld appears in Box 1 (Wages, Tips, and Other Compensation), along with regular earnings. State income tax withholding is shown in Box 17, while State Disability Insurance (SDI) contributions, if applicable, are listed separately. Employees should verify these amounts against their final pay stub for accuracy. Any discrepancies should be addressed with the employer before filing.

If too much tax was withheld, the employee may be eligible for a refund when filing California Form 540. In some cases, estimated tax payments may be necessary if total withholding is insufficient to cover annual tax liability. This is particularly relevant for those receiving large vacation payouts that significantly increase taxable income. Reviewing total earnings and tax brackets can help determine whether additional payments are needed to avoid underpayment penalties.

Taxpayers who itemize deductions should also consider how vacation payouts impact their overall financial situation, as higher income levels may affect eligibility for certain credits or deductions.