Does an Employer Have to Pay an Employee for Unused Vacation Upon Termination?

The federal Fair Labor Standards Act dictates what employers can deduct from final paychecks, but not the paid time off compensation they must include. However, many states have legislation that stipulates when and if employees must receive payment for any unused vacation they have earned. An employee's eligibility to receive payment for accrued leave depends on how these statutes define "wages" and whether the employer has a written policy communicated to employees upon hire for computation, accrual and eligibility of paid personal, sick, holiday and vacation days.

Definitions Make a Difference

According to Business Management Daily, 12 states have no law that addresses an employer's obligation to pay unused vacation when an employee separates. Employers can base leave policy on how their state defines wages as remuneration. For example, Indiana and Pennsylvania labor laws regard vacation as a fringe benefit and only require employers to compensate workers for actual time worked unless a written policy states otherwise. Vacation pay under California law cannot be forfeited once earned because it's considered part of an employee's wages. In Delaware, vacation pay is a wage supplement that employers don't have to pay unless they have a written policy to do so, while Nebraska excludes paid leave from wages payable upon termination, but requires employers to pay accrued vacation leave. Although Arizona includes vacation in its definition of wages, it defers payout of accrued vacation time to the employer's written policy.

Employee Handbook Reigns

Employers with established written policies for paid time off, including personal, sick, holiday and vacation days, must give a copy of these policies to employees when hired and distribute any subsequent updates to everyone on the workforce in order to justify eligibility for leave payout upon termination. Maryland and New York legislation specifies that lack of a written forfeit policy entitles a departing employee to be paid unused, accrued vacation leave. More than half of U.S. states require employers to adhere to company policy or past practice.

Policy wording must be specific, however, to avoid payout obligations. For example, the Louisiana court has ruled that although an employer doesn't define vacation as paid time off, it is obligated to pay unused vacation leave when employees accrue such paid time according to its written policy.

PTO Program Challenges

PTO programs don't distinguish sick leave from vacation leave. The growing popularity of this benefit in which all paid leave is lumped together makes the language used to describe a company's leave policy more critical. Using the term "earned" obliges the employer to pay any time left in an employee's PTO "account," according to a recent court ruling in Nebraska. Under Illinois law, a PTO policy that lets employees earn paid time off for any purpose must treat that paid time away from work as earned vacation, payable upon termination when unused. Employers can eliminate their compensation risk exposure by instituting a PTO policy in which leave benefits "accrue," cannot be carried over into another calendar year and will not be included in a terminated employee's final pay.

Employers can choose to weave incentives into their vacation payout policy to encourage employees to provide advance notice when leaving. For example, an employee might forfeit any vacation time due him for failure to provide at least a two-week written notice.