Thinking About a PTO Cash-Out Policy? Read This First

Paid time off (PTO) is one of the most valued benefits employees receive. But when workers don’t use all their time, employers often face a decision: should they pay it out, and if so, how do they handle it?

For construction companies and other blue-collar businesses, poor planning around PTO cash-out can lead to cash flow surprises, tax headaches, and even penalties. This article walks through what a PTO payout is, what the law requires, and how to build a PTO cash-out policy that protects your business and supports your team.

What Is a PTO Payout?

A PTO payout happens when you pay an employee for unused paid time off. Some businesses do this when an employee leaves. Others allow workers to cash out some PTO at the end of the year or during slow seasons.

For hourly workers and construction crews, this can be a way to boost income without needing to take time off. But if your PTO policy isn’t clearly written and well-managed, it can cause more problems than it solves.

When Should You Pay Out PTO?

Whether you must provide a PTO cash-out option depends on two factors: your company’s policy and your state’s laws.

In most cases, if your policy says you pay out unused PTO, then you’re obligated to do so. And some states require a PTO payout, whether you have a policy or not. For example:

• California treats accrued PTO as earned wages. You must pay it out when an employee quits or is fired. “Use-it-or-lose-it” policies are not allowed.

• Montana also requires payment of accrued vacation time upon separation from employment.

• Illinois now bans use-it-or-lose-it PTO policies and generally requires businesses to pay out unused time when an employee leaves.

• Florida, on the other hand, doesn’t require PTO payout by law—it’s up to company policy.

Before finalizing your PTO payout policy, check your state labor department’s website or speak with an employment law expert.

PTO Cashouts Are Taxable (Don’t Let That Surprise You)

Here’s a detail some employers (and employees) overlook: PTO cash-out is considered income and is subject to payroll taxes.

That means:

• You must withhold income tax, Social Security, and Medicare.

• You’ll need to report the PTO payout on the employee’s W-2.

• If you miscalculate or fail to withhold the right amount, you could face IRS penalties.

If your PTO policy allows large cashouts—say, someone cashes out 80 hours—it could bump their taxable income and create a bigger tax bill than expected. For your team, that can feel like an unpleasant surprise. Read this for more tips on how to mitigate payroll tax errors.

Beware the Tax Trap: Constructive Receipt Rules

When it comes to PTO cash-out policies, there’s a hidden tax issue that many business owners overlook, called “constructive receipt.” That’s IRS-speak for saying income is taxable the moment an employee has access to it, whether or not they actually take it.

Say your PTO policy allows workers to cash out up to $10,000 of unused time each year, no questions asked. Even if someone doesn't request a payout, the IRS might still treat that amount as income because the employee could have taken the money. That means extra taxable income, even without a paycheck to show for it.

And if you’ve been doing this for a while, there’s a real risk that you’ve underreported wages and under-withheld taxes for multiple years.

How to Avoid the Tax Trap

To stay compliant and avoid a mess during tax season, consider building one of these safer structures into your PTO cash-out policy:

• Choose in advance. Let employees decide—before the year starts—whether they want to accrue PTO or receive cash.

• Allow payouts only for financial emergencies. Set strict guidelines for hardship requests, and make sure management has the final say.

• Limit payouts to separation. Stick with PTO payout only when someone leaves the company.

• Redirect excess PTO. Automatically send unused time above a certain cap into a benefit plan like a profit-sharing account or a health reimbursement arrangement.

These options help employees benefit from their unused time, without triggering unwanted tax bills or compliance issues for your business.

The Cost of Poor PTO Planning

A loosely written PTO cash-out policy can be costly. Without clear rules or caps on accrual, some businesses end up with large payout obligations they didn’t budget for.

For example, if your field crew hasn’t taken time off in a year, and they all decide to cash out PTO in December, you could be on the hook for tens of thousands in payouts during your slowest season. That’s a cash flow crunch no business wants.

Common pitfalls include:

• No cap on PTO accrual: Leads to massive liabilities.

• No regular tracking: You lose visibility into what’s owed.

• Lack of clarity on separation: When someone quits or is fired, confusion over payout can lead to disputes or even lawsuits.

Tips for a Strong PTO Cash-Out Policy

Protect your business and care for your crew with a clear, fair, and legally compliant PTO payout policy. Here are a few practical tips:

1. Put it in Writing and Ensure Your PTO Policy Includes:

• How PTO is earned and accrued

• Whether it can be cashed out and under what conditions

• What happens to unused PTO at the end of the year

• Whether PTO is paid out when someone leaves

2. Know Your State’s Laws

Since your policy must not override local laws, confirm if your state requires payout on termination or bans “use-it-or-lose-it” terms. Update your policy as laws change.

3. Set Accrual Caps

Limit the amount of PTO an employee can accumulate. This keeps your liability manageable and encourages workers to take their time off.

4. Offer Scheduled Cashouts

Consider offering annual or semi-annual PTO cash-out ‘windows.’ For example, letting employees cash out up to 40 hours in December can give your team flexibility while helping you plan and budget.

5. Communicate Clearly

Make sure your employees understand how the policy works. Use plain language, include it in onboarding, and remind your team before year-end if cashout options are available.

6. Use a Payroll or HR System

Tracking PTO balances in real time helps you stay compliant and ensures accurate payouts and tax reporting.

7. Encourage Time Off Over Cashouts

If your goal is to protect your cash flow and support employee well-being, you can design your PTO policy to favor time off over payouts. For example, offer employees 100% value when they take time off, but only 80% if they choose to cash out their PTO instead.

This kind of policy nudges workers to rest and recharge while reducing the financial strain that large PTO payouts can create at the end of the year. It’s a win-win: Your crew gets time off, and your business stays stable.

Bottom Line: Avoid PTO Cash-Out Headaches

A smart PTO cash-out policy does more than follow the law; it protects your business from financial stress and builds trust with your team. Whether you’re running a roofing crew, plumbing outfit, or any small business, taking the time to write a solid PTO payout policy pays off.

Get ahead of the problem now, and you won’t be scrambling later when someone quits—or when tax season rolls around.

Need help writing or updating your PTO policy? Talk to us at JLS Accounting to ensure your approach keeps you compliant and cash-flow ready