California employers do not have to offer employees vacation, or “PTO” (paid time off).  Many employers choose to do so, because time away from work not only benefits employees, but also can improve productivity, inspire loyalty, and reduce “burn-out.”

Once employers offer vacation or PTO, their policies and procedures must comply with California wage-hour law. Labor Code section 227.3 is the only statute governing vacation.  It requires employers to pay departing employees unused, “vested vacation . . . as wages at his final rate in accordance with such contract of employment or employer policy respecting eligibility or time served.” The statute also provides: “an employment contract or employer policy shall not provide for forfeiture of vested vacation time upon termination.”

The California Supreme Court has interpreted section 227.3 to say that vacation “accrues” or “vests” over time. Once vested, vacation cannot be forfeited. That is why “use it or lose it” policies – requiring employees to take vacation in the year it is earned or it is forfeited – are illegal.

Courts and the California Division of Labor Standards Enforcement have added additional complexity, and risk of significant financial liability.  However, employers retain flexibility to draft vacation policies to best suit their businesses, as shown below.

Delayed Accrual Periods

California employers may delay an employee’s eligibility to earn vacation, to avoid granting paid vacation to employees whose employment terminates shortly after hire.  The court of appeal in Minnick v. Automotive Creations upheld a policy that employees only begin to accrue vacation time after a completing a full year of employment.

Conditions on Use

Generally speaking, if the employer pays out all unused, earned vacation upon termination of employment, the law will not interfere. Employers therefore have considerable control over the timing and use of vacation time.  A retailer could forbid the use of vacation time during a busy holiday shopping season, for example.  Or an employer could limit the length of vacations to five consecutive workdays.

However, when company policy “caps” the amount of vacation an employee can earn, the Division of Labor Standards Enforcement or a court may scrutinize whether conditions limited employees’ use so much that reaching the cap is inevitable.

Employers also may pay out accrued, unused vacation time in cash at year’s end.  Some employers favor such policies to avoid large liabilities on their balance sheet, and to avoid paying out vacation time at a (presumably) higher pay rate.

Accrual Caps

As mentioned, California employers may impose reasonable caps or “maximum accruals” on vacation time.  If an employee reaches the maximum balance allowed without taking vacation time, his or her vacation hours stop accruing until the balance falls below the cap. Note that the cap must be sufficiently generous to give employees a chance to take earned vacation before reaching the cap.

A cap is legal because it merely stops the accrual of as-yet unearned vacation time.  In contrast, a policy under which unused vacation is forfeited – “use it or lose it” – is illegal because such policies take away what employers have already granted. 

Pay at Termination

The courts have held that vested vacation pay is a form of wages. This means the employee must be paid accrued, unused vacation at the same time as final pay – generally on the last day of employment.

The calculation of vacation pay at the time of separation is determined on a prorated daily basis.  For example, an employee entitled to take ten vacation days each calendar year who quits on January 31st is entitled to 31/365ths of those ten days.

Failing to timely pay vacation, or miscalculation of the amount owed, create the risk of up to 30 days’ “waiting time” penalties under Labor Code Section 203.

Vacation Pay Rates

The employer is free to set vacation pay rates. For example, employers need not set the vacation pay rate to sales employees based on the commissions they earn.  In fact, employers may set vacation pay at any rate they choose.  Once set, however, the employer cannot reduce that pay rate retroactively.     

PTO v. Sick Leave  

Many employers elect to combine paid vacation time and sick leave into “paid time off” (PTO) plans.  In California, PTO time is treated the same as vacation time.  On the other hand, paid sick time and other paid leave that is not available until the occurrence of a condition (e.g., observed holidays, birthdays, bereavement) are not “vested” and may be forfeited if not used.

Employers should be mindful of the consequences of combining sick and vacation time, given the new paid sick leave laws and ordinances.  For example, sick pay must be paid at certain rates; but employers may set vacation rates freely. As another example, lawful delayed eligibility for vacation time may run afoul of sick leave laws. Employers therefore must ensure a PTO plan complies with sick leave laws and ordinances, or offer sufficient, separate paid sick leave under a compliant sick pay policy.

Repayment of Advanced Vacation

Some employers allow employees to take vacation before it is actually earned.  This practice may result in a type of employee debt, if employment ends before the employee has accrued sufficient vacation time to repay the advance.  

Employers are not allowed to engage in “self-help” to recover employees’ debts, by deducting the advance from the employee’s final paycheck.  Instead, the employer is treated the same as any creditor and must pursue repayment by the same means as any other party owed money by the employee.         

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