How Paid Time Off (PTO) Cash-Outs Are Taxed (2026)
When employees leave a company or cash out accrued vacation days, they are frequently shocked by how much smaller their payout check is than expected. This guide explains how the IRS taxes PTO cash-outs, supplemental withholding rules, and how excess tax is refunded.
Why PTO cash-outs are taxed higher upfront
When you take a paid day off while employed, your pay is disbursed as regular wages on your standard payroll schedule with your normal withholding rate.
However, when accrued, unused paid time off is cashed out—either upon resignation, termination, or annual company buy-back—the IRS categorizes the payment as supplemental wages under Treasury Regulation § 31.3402(g)-1. Supplemental wages include bonuses, commissions, severance, and accumulated leave payouts.
The two federal withholding methods for PTO
Employers must withhold federal income tax using one of two approved IRS methods:
Method 1: flat 22% supplemental withholding
If the PTO payout is disbursed as a separate check or itemized distinctly from regular wages, the employer can withhold federal income tax at the optional flat rate of 22.00% (for eligible supplemental wages up to $1,000,000, when regular wages had income tax withheld in the current or preceding year).
Method 2: the aggregate payroll method
If the PTO payout is bundled together with your regular paycheck into a single lump sum, the payroll software combines both amounts and annualizes the total to calculate tax withholding. Because the check appears artificially massive, the system temporarily pushes you into higher tax brackets (24%, 32%, or 35%), taking a substantially larger bite from the check.
The full deduction breakdown on a PTO cash-out
In addition to federal income tax, PTO cash-outs also face payroll and state deductions:
- Federal income tax: 22.00% (flat rate) or aggregate payroll rate.
- Social Security tax (OASDI): 6.20% (up to the $184,500 annual wage cap in 2026).
- Medicare tax: 1.45% (plus 0.9% on earnings exceeding $200k single / $250k married).
- State income tax withholding: Varies by state. State supplemental withholding and payroll contribution rules vary. Check the state tax agency schedule; an income-tax-free state can still have other payroll deductions.
Illustrative percentage-method example for 80 hours at $50/hour, below the FICA thresholds. The state rate below is an assumption, and actual withholding may use a different method:
- Gross PTO Payout: $4,000.00
- Federal Supplemental Tax (22%): −$880.00
- FICA Taxes (7.65%): −$306.00
- California State Tax (6.6%): −$264.00
- California SDI: check the current EDD rate; not included in this subtotal
Subtotal before SDI or other deductions: $2,550.00
Will you get overwithheld taxes back?
A refund is possible, but not guaranteed. Withholding is not your final tax liability; it is merely an estimated pre-payment sent to the IRS. When you file your annual tax return (Form 1040), your total annual income—including the PTO cash-out—is reconciled against your actual tax brackets and standard deduction.
Your refund or balance due depends on total income, deductions, credits, withholding, and other payments. Comparing a payout withholding rate to your average tax rate does not establish a specific refund.
Whether unused leave must be paid out
Payout rights depend on state law, the type of leave, and the employer's policy. Vacation, combined PTO, and sick leave can have different rules. In California, earned vacation is generally treated as wages and must be paid when employment ends; this does not mean every type of sick leave must be cashed out. See the California Labor Commissioner's vacation FAQ. For another state, consult that state's labor agency and your written policy.
Estimate your take-home cashout using our PTO Payout Calculator (After Taxes).