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This blog post is written for American businesses. Click here for 4 Ways to Handle Vacation Pay in Canada.

Numerous studies have shown that rest and happiness play a critical role in how productive your employees are going to be when they are at work. So, it seems fairly obvious that you need to implement some kind of vacation policy or PTO plan.

This is where things get tricky.

There are no rules in the US that force employers to offer paid leave, but vacation time is a fairly commonplace benefit offered by most companies. And then there are the different types of vacation policies in place at startups that want to build the best company culture.

So, in the face of all these unlimited paid time off possibilities, how should you structure the vacation policy for your own small business or startup?

Well, let’s look at how paid time off programs are typically set up to get an idea of what structure might work best for your small business or startup.

Paid Time Off (PTO)

Companies are starting to move in the direction of offering a single PTO policy vs. splitting them up into vacation, sick, floating holidays, personal days, etc.

A single PTO policy offers a myriad of benefits, such as:

  • A combined bank of days for an employee to draw down, irrespective of the reason for the time off.

  • Easier to track, especially if all your employees receive the same number of days to use each year.

  • Part-time employees don’t have to be exempted as they can participate under the same plan on a pro-rated basis.

Accrued Paid Leave

Ever wonder who came up with the word accrued… for a word that sounds like a rash, it actually has a very positive meaning.

To keep things in context, accrued paid leave means an employee has accumulated all this time under a specific paid time off plan e.g. vacation, but it has not yet been used or paid out by the employer.

Vacation leave is usually accrued per pay period; so, a full-time (40 hours/week), non-exempt employee who accrues vacation leave of 80 hours per year would accrue 3.0769 hours per biweekly pay period.

There are 24 states in the US that require accrued paid leave to be treated as wages and be paid out to a departing employee. If you are a registered employer in any of the following states – Alaska, Arizona, California, Colorado, Illinois, Indiana, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Minnesota, Nebraska, New Hampshire, New York, North Carolina, North Dakota, Ohio, Oklahoma, Pennsylvania, Rhode Island (after one year of employment), Tennessee, West Virginia, and Wyoming and / or the District of Columbia, you have to include any unpaid accrued vacation pay in the final paycheck.

A challenge with the accrued paid leave policy arises if an employee wants to take time off early in the year, but he/she has not actually accrued that time as yet. This could cause an issue particularly if the employee leaves and has a negative vacation balance at that time, which could make it hard for you to get that amount back from your employee. This is the reason why certain states do not allow employers to include deductions on a final paycheck.

Up Front

This type of a PTO plan is certainly simpler from a mathematical standpoint because if, for instance, your plan allocates 80 hours of vacation for a year, your employees will get paid out for all 80 hours at the start of the calendar year or on their hire date.

There’s nothing you need to track in this case as it’s an upfront payment – hence the name, we think.

But thinking of cons… this also means that if the state your employee works in requires you to pay out all earned days when an employee is terminated, you would have paid the entire 80 hours worth of vacation pay irrespective of the date your employee left the company.


Last but not least, you have the tiered PTO plan, which is the scenario where different groups of employees have a different plan.

For instance, tenure-based leave plans are a tiered system in which employees get vacation time based on how long they have been with the company. It certainly offers one alternative to motivate employees to stick around with you for the long term.

Another example of a tiered PTO plan is based on job roles/titles where senior/management team members have more vacation time as a benefit.

Now that you have a better understanding of the different ways you can structure a paid time off policy, the last few things you need to think about are related to carrying over vacation and how you want to handle vacation payouts in the cases of termination or when an employee resigns.

Most states, with the exception of California and Montana, allow employers to decide whether or not they want to allow employees to carry over any unused vacation. If you fall in the pro-carryover camp, you can put some limits in place that only allow employees to carry over five days at the most and require them to use those days within the first two or three months of when it was carried over.

As for paying out employees who are terminated or have wandered to greener pastures, you need to think about whether you want to pay out accrued leave or if you want to handle it all upfront. This is dependant on the state your employees work in i.e. some states make paying out mandatory whereas other states allow employers to decide at their own discretion.

And you thought the hard part was going to be deciding where to go on vacation.

Disclaimer: The advice we share on our blog is intended to be informational. It does not replace the expertise of accredited business professionals.