Vacation Pay: What It Means for Employers

What it means in practice

Vacation pay covers two kinds of payment: pay while on vacation, and cash for vacation earned but not taken, either as an annual cash-out or as a lump sum when employment ends. Combined banks of vacation, sick and personal days are covered on the paid time off (PTO) page, and how balances build up is covered under accruals. This page covers the pay itself: when it is owed, how it is computed and when it must be paid out.

The federal baseline. The Department of Labor says the FLSA does not require payment for time not worked, such as vacations, sick leave or holidays, and that these benefits are matters of agreement between an employer and an employee or the employee's representative. Its vacation leave page notes that on covered Service Contract Act (SCA) contracts vacation requirements are set in the wage determinations, and that under the Davis-Bacon and Related Acts vacation pay is required only if the wage determination specifies it. The DOL pages read for this entry set no federal rule for paying out unused vacation at separation; that turns on policy and state law.

Vacation pay on Service Contract Act contracts. Contractors covered by the SCA (see prevailing wages) follow 29 CFR 4.173. A typical fringe benefit determination reads "one week paid vacation after one year of service with a contractor or successor." Unless the determination says otherwise, length of service counts all continuous time with the current contractor, on commercial work as well as on the government contract, plus continuous time with predecessor contractors that performed similar functions at the same federal facility. Leave, illness and temporary layoffs do not break service, but a quit, a discharge for cause or another termination does.

When SCA vacation vests and what rate applies. Under the same regulation, the vacation vests on the employee's anniversary date and each anniversary after that. There is no accrual before the anniversary, and no period shorter than a year need be counted unless the determination provides for it. The regulation's example: an employee who works 13 months and separates without any vacation is owed one week (40 hours), not an extra one-twelfth of a week. The vacation must be given, or paid in lieu, before the next anniversary date, the end of the current contract or the employee's termination, whichever comes first. Liability is not prorated between contractors: the contractor employing the worker on the anniversary date owes the full benefit. If the wage rate rises during the contract, vacation pay is computed at the rate in effect in the week the vacation is taken or paid.

Vacation pay and overtime. Payments for occasional periods when an employee is not working because of vacation, in amounts approximately equal to normal earnings for a similar period, are not compensation for hours of employment. They may be excluded from the regular rate, and no part of them may be credited toward overtime due (29 CFR 778.218). The same applies when an employee forgoes vacation and is paid for it instead, whether in the pay period of the forgone leave or as a later lump sum (29 CFR 778.219). The regulation adds that vacation pay is a matter of private contract, not a statutory right. For how the regular rate works, see overtime.

Example: a year-end cash-out. The third example in 29 CFR 778.219 involves an employee paid $12 an hour who usually works 40 hours and is entitled to two weeks of paid time off a year. The employee takes one week and receives $480 for the unused week at year end (40 x $12). The payout may be excluded from the regular rate, but none of it may be credited toward overtime due. As a hypothetical extension, if that payout fell in a week in which the employee worked 45 hours, the employee would be owed $540 straight time (45 x $12) plus a $30 overtime premium (5 hours x $6), and the $480 would be owed on top of both without reducing the $30.

Exempt employees and vacation banks. The salary basis rule says an exempt employee must receive the full salary for any week in which any work is performed, with listed exceptions (29 CFR 541.602). Its Field Operations Handbook (Chapter 22, section 22h05(d)) says an employer with a leave bank for vacation and similar uses may deduct from that bank for an exempt employee's absence, even one of less than a full day, as long as the employee receives the full guaranteed salary. An exempt employee with no accrued leave who is absent for less than a full day must still be paid the full guaranteed salary. Opinion letter FLSA2005-7 says the full-day rule applies to salary, not to the leave bank. When vacation is exhausted, the salary itself may be reduced only for absences of one or more full days for personal reasons; for an absence of one and a half days, only the full day may be deducted (29 CFR 541.602(b)(1)). Section 22h09(d) adds that an employer may require leave to be used on specific days, such as a weather closure, if the guaranteed salary is still paid. For classification, see exempt vs. non-exempt.

Example: a partial bank. The Handbook's own example is an exempt employee paid $1,000 a week who has four hours of accrued leave and misses a full eight-hour day. The employer complies with the salary basis rule if it deducts the four hours from the leave bank and pays the employee $100 for that day, half of one day's salary.

Why improper deductions matter. Under 29 CFR 541.603, an actual practice of improper deductions means the exemption is lost, for the period of the deductions, for employees in the same job classification working for the same responsible managers. Isolated or inadvertent deductions do not cost the exemption if reimbursed.

Tax withholding. IRS Publication 15 (2026) says vacation pay is subject to withholding as if it were a regular wage payment. When vacation pay is in addition to regular wages for the vacation period, such as an annual lump-sum payment for unused vacation, it is treated as a supplemental wage payment. If vacation pay covers a time longer than the usual payroll period, it is spread over the pay periods for which it is paid.

ERISA. ERISA's welfare plan definition includes vacation benefits, but under 29 CFR 2510.3-1(b)(3)(i), vacation pay paid out of the employer's general assets is a payroll practice, not a welfare plan, for purposes of Title I.

Federal employees. Federal agencies follow separate OPM rules that do not apply to private employers. Full-time employees earn 4, 6 or 8 hours of annual leave per pay period depending on years of service, most may carry over 30 days, and leave above the ceiling is forfeited at the end of the leave year unless restored. On separation, an employee receives a lump sum equal to the pay the employee would have received had employment continued until the unused annual leave ran out.

Where states differ. Most vacation pay rules come from the states. The three below are examples from official pages, checked November 2026; other states differ.

Example state: California. The Labor Commissioner's vacation FAQ says California does not require vacation, but earned vacation is wages that vest as labor is performed and cannot be forfeited at termination for any reason. The FAQ also says an employer may exclude classes of employees, such as part-time workers, if the policy says so clearly; may control when vacation is taken; may cap accrual at a reasonable level; may pay out unused vacation each year; and may set a genuine waiting period that is not a subterfuge. Unless a collective bargaining agreement provides otherwise, unused vacation must be paid at the final rate of pay (Labor Code 227.3). The Labor Commissioner's final pay FAQ says a discharged employee must be paid all wages, including accrued vacation, immediately; an employee who quits with at least 72 hours' notice is paid at quitting, and one who quits without notice is paid within 72 hours (Labor Code 201 and 202). See California labor laws.

Example: a California waiting time penalty. The final pay FAQ says an employer that willfully fails to pay a departing employee's wages on time may owe a waiting time penalty equal to the employee's daily rate of pay for each day the wages remain unpaid, up to 30 calendar days, with no penalty where a good faith dispute exists (Labor Code 203). As a hypothetical, an employee with a daily rate of $200 whose vacation payout is willfully withheld for 12 days could be owed a $2,400 penalty (12 x $200) in addition to the vacation pay.

Example state: Texas. The Texas Workforce Commission says the Texas Payday Law does not require vacation pay, but an employer that offers it in writing must follow its policy. Unused vacation must be paid at separation only if the written policy or agreement provides for it, and a policy that is silent on accrued, untaken leave is not enforceable under the Payday Law. Final pay is due within six calendar days after a layoff or discharge and on the next regularly scheduled payday after a resignation. TWC's guide adds that before making a post-termination lump-sum payment, such as a leave payout, of $500 or more, the employer must notify the Attorney General's office so it can determine whether a child support deduction applies.

Example state: Nebraska. Under Neb. Rev. Stat. 48-1229(6), paid leave other than earned but unused vacation leave is not included in the wages due at separation unless the parties have agreed otherwise, so earned vacation is. The case notes on the statute say unused paid time off counts as vacation when the only condition for earning it is rendering services and it may be used for any purpose, while a sick-only benefit with no cash value at termination is permitted. Under 48-1230(4), a private employer must pay unpaid wages on the next regular payday or within two weeks of termination, whichever is sooner.

Questions employers ask. Must vacation be paid out when someone leaves? Not under the federal rules read for this entry; California and Nebraska require payout of earned vacation, and Texas requires it only if the written policy promises it. Can an employer pay cash instead of time off? California's FAQ allows an annual payoff of unused vacation, and 29 CFR 778.219 explains how such a payment is treated for overtime.

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