State Laws on Paid Time Off

Many employees delay using their accrued time off, and so firms have rewritten their paid time off (PTO) policies to allow unused days to roll over into the next year.

Does your state require employers to pay out PTO? If your company has locations in many states, you need to review all statutes regarding separation pay. Still, it’s wise to check state departments of labor for specific guidelines.

Every state has its own PTO laws, and they can vary widely. Here’s a small sample of laws you or your counterparts at other companies may be dealing with.

California

• In California, earned vacation time is considered wages. Therefore, employees cannot be deprived of earned, unused vacation time no matter what the reason for separation, unless an agreement has been met by both parties. You may, however, implement a practical accrual cap on vacation time.

Illinois

• Illinois considers vacation or other paid time off (PTO) to be earned wages and therefore must be paid out at termination. Employer policies contrary to the law are invalid.
  
  Use-it-or-lose-it policies are allowed only on a benefit year-basis (not at termination) and only if the employee is informed of the policy and given ample opportunity to take the time off. For example, a policy may indicate that employees are entitled to five days of PTO per calendar year and that unused days will be forfeit on December 31. If the policy is communicated—preferably in writing—and employees are granted PTO when requested in accordance with company policy (the employer must not make it difficult to use time off), then forfeiture of unused time will be acceptable.

Minnesota

• For Minnesota, earned vacation time is considered wages when your company has established policies or a precedent of paying employees for this time.
  • Use it or lose it policies are not addressed by state law.
  • Your policy or employee contract governs whether earned, unused vacation is paid on separation.

Nebraska

• For Nebraska, vacation pay is a type of fringe benefit and considered wages. Use it or lose it is prohibited by law. You’re liable for paying separating employees any earned, unused vacation time.

Texas

• In Texas, if you offer vacation pay, your workers must honor the terms of your policy or employment contract. Use it or lose it is not addressed by state law. Your policy or employment contract governs whether earned, unused vacation is paid on separation.

Another problem is that you may inadvertently create tax consequences through PTO cash-out options and PTO donation policies. When employees are given a choice between cash and PTO, employees are treated as constructively receiving cash whether or not they exercise that option. The tax system views it as receiving cash. Depending on your local laws, you may be obligated to withhold payroll tax.

Allowing employees to donate unused days to other workers triggers tax rules that require the individual who earned the PTO to report the income, even though he or she didn’t receive it. But the IRS says if you donated your PTO for medical or major disasters, then the employee who receives the PTO has taxable compensation.

Paid time off is used to attract and retain talent. Don’t let any inadvertent regulatory or tax consequences neutralize any good business effect.