California Labor Law: Vacation Pay Is Earned Compensation
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California law provides that accrued vacation time or PTO belongs to the employee. Employees may either use their vacation time during their employment, or cash out the value of those hour at the time of their separations. When an employee quits or is fired or laid off, all accrued, unused vacation time must be included in the employee's final paycheck.
According to California law, PTO and vacation are wages that have been earned by, but not yet paid to, the employee. Once you earn vacation or PTO, it cannot be taken away. This means "use it or lose it" policies, in which employees must use vacation by a certain date or forfeit it, are illegal in California.
The catch is that employers aren't legally obligated to offer vacation or PTO in the first place. If they do, however, then they must comply with the law.
In the case of Suastez v. Plastic Dress-Up Co., 31 Cal.3d 774, 782 (1982), the employer’s policy declared that one week of PTO/vacation would accrue after one year of employment. The California Supreme Court held that the PTO/vacation time was not earned at the end of the year, but instead earned on a pro-rata basis as the employee worked (typically during each pay period). In other words, an employee earned half a week of vacation after working for six months and was entitled to those wages.
Although "use it or lose it" vacation policies are not allowed in California, an employer can place a cap on vacation accrual. The California Division of Labor Standards Enforcement (DLSE), the agency that enforces wage and hour laws, has given some guidance on how the cap should be formulated. While the DLSE previously declared that a cap on accrual must be at least 1.75 times the annual accrual rate, it has since backed off this bright-line rule. Instead, the DLSE simply states that the cap must be "reasonable." It stands to reason that a 1.75 cap is still the most conservative route, but that a 1.5 cap may also be considered reasonable under California law.
Example: An employer's policy provides employees with two weeks of vacation each year. The employer may place a cap of 3.5 weeks on vacation (2 weeks x 1.75 cap). Once the employee accrues 3.5 weeks of vacation, the employee will not accrue any more vacation until he or she falls below the cap.
Employers are also permitted to pay out (or allow employees to "cash out") any accrued but unused vacation time at the end of the year, or another specified time. Because employees are being paid for their earned wages, this type of policy is also perfectly legal.
Employers cannot, under any circumstances, refuse to pay an employee accrued vacation if the employee quits or is fired or let go. All unused vacation time must be paid out upon separation from the company in the employee's final paycheck. The timing for final paycheck in California depends on the circumstances of the separation. If the employee is terminated or laid off, the employer must provide the final paycheck at the time of the employee's termination or layoff. If the employee quits and provides 72 hours' notice, the employer must provide the final paycheck on the employee's last day. If the employee quits and provides less than 72 hours' notice, the employer must provide the final paycheck within 72 hours of the date the employee gave notice. Because vacation time is considered wages, waiting time penalties will apply should the employer fail to pay the employee within these time frames. For more information on waiting time penalties, see California's Waiting Time Penalties for Final Paychecks.
Sick pay is not considered vacation time and therefore not subject to these rules. If an employer has a stand-alone sick leave policy, sick pay does not need to be paid out upon separation from the company. However, if your employer lumps both sick and vacation time together into PTO, then all of the PTO time is treated like vacation time. For more information on the rules that apply to sick leave, see Nolo's article on California's mandatory sick leave policy.
Similarly holiday pay for fixed holidays, such as New Year's Day or the Fourth of July, are not considered vacation and do not need to be paid out on separation. However, "personal days" or "floating holidays," which are not tied to any specific day and can be used by employees whenever they wish, are treated as vacation and are subject to the same rules.
If you believe that your current or previous employer may be in violation of California labor laws regarding vacation pay, PTO, holidays, or sick pay, you may want to contact a California labor law attorney.