This topic contains the following information:

• Vacation Defined
• Vacation Is a Form of Wages
• Vacation Benefit Waiting Period
• Vacation Policy Considered a Contract
• Unlimited Vacation Policies
• Advance Notice of Vacation During Plant Shutdown Required
• No Use it or Lose it Policies Allowed
• Reasonable Cap on Accrual Allowed
• Cash-Out Policies Allowed
• Vacation Can Be Taken Before it Is Earned
• Requiring Advance Notice of Vacation
• Pay of Accrued Vacation at Termination
• Employee Retirement Income Security Act (ERISA) Exemption and Vacation Plans
• Partial Day Vacations for Exempt Employees
• Sabbatical Versus Vacation
• Rules for Providing Vacation
• Use of Vacation During Leaves of Absence
• Communicating Vacation Policies to Employees
• Vacation Policy Best Practices

Vacation Defined

A vacation is any paid time off earned as a benefit. Any “personal holiday” (sometimes referred to as a “floating holiday”) that is not associated with any specific event, such as a birthday or holiday, is treated as vacation.

You can choose not to offer paid vacation time as a benefit. If you do provide paid vacation time, you have the right to set how much paid vacation time employees can earn each year.1 You also have the right to determine when employees may or may not take vacations and the length of the vacations.

Vacation is a Form of Wages

Paid vacation leave constitutes a form of wages.2 PTO is also a form of wages (see Paid Time Off). The right to vacation vests as the employee renders services, so employees earn a portion of the annual vacation each day.3 If employees receive two weeks of vacation per year (80 hours), vacation accrues at a rate of approximately 0.30 hours daily. If employees receive one week of vacation per year (40 hours), vacation accrues at a rate of approximately 0.15 hours daily.4

Vacation Benefit Waiting Period

If vacation is offered as a benefit, the law does not require that the accrual begin the first day of employment. An employer may set a waiting period before vacation accrual actually starts. The employer is free to determine when an employee becomes eligible for vacation benefits so long as eligibility and vesting occur simultaneously. Thus, a “waiting period” for vacation benefits to accrue and vest is permissible.

For example, a California court recently ruled that an employee who worked less than one year was not entitled to vacation pay at the time of termination because the company had a lawful policy stating that employees don't start to earn vacation until after their first year of employment.5 The court said: “[I]f the employer's policy is clearly stated, the waiting period is enforceable.”

In another case, a California court upheld a vacation policy that stated that employees did not accrue vacation until after they completed six months of employment.6

You can adopt a policy that specifies the amount of vacation pay an employee is entitled to accrue, based on length of service. When an employee starts their employment, notify the employee when vacation accrual begins, the amount to be accrued, any caps on accrual or restrictions on the use of vacation.

Vacation Policy Considered a Contract

Because paid vacation leave is a form of wages earned by an employee, paid vacation is also part of the “employment contract” between you and the employee. As part of that contract, the employee performs specific duties in exchange for compensation, which, in this situation, includes both regular wages and vacation time earned.

Due to a contract being created, it is critical that you clearly state your vacation policy. The policy should include how much vacation you offer and the rate at which vacation days are earned. The policy should also state whether an employee earns vacation days beginning on the first day of employment or after some period of time has passed.7

Advance Notice of Vacation During Plant Shutdown Required

You can require that employees take vacation at a specific time of the year; for example if your company shuts down during certain times of the year. Similarly, you can prohibit the use of vacation at a specific time of the year.

You should give reasonable advance notice if you require the use of, or prohibit the use of, vacation at a specific time. Typically, reasonable advance notice is 90 days.

You also may want to examine issues relating to exempt employees’ salaries if your shutdown is for less than a full workweek. For more information, see Deductions From an Exempt Employee’s Salary.

No Use It or Lose It Policies Allowed

After an employee earns vacation, you cannot take it away. California courts and the Labor Code prohibit a “use it or lose it” policy, in which employees lose earned vacation if it is not taken by a specific time.8 You cannot require employees to forfeit accrued vacation for any reason. You may place a reasonable cap on vacation.

There is one exception: If a collective bargaining agreement forms the basis for employees’ earned vacation time, and contains a provision expressly waiving the Labor Code’s anti-forfeiture provisions, the Labor Commissioner will allow use it or lose it provisions. If you eventually pay the vacation time, the Labor Commissioner may impose waiting time penalties on late payment.9

Reasonable Cap on Accrual Allowed

Under a reasonable cap plan, after an employee accrues a certain level of vacation, but does not take the time, vacation no longer accrues until the employee takes some of the previously accrued time.10 After the employee takes some vacation, they begin to accrue time at the usual rate. You are not required to retroactively grant the employee the amount they would have earned during the time the vacation was at the cap.

The cap should be reasonable, based on factors such as:

• The amount of vacation offered
• The opportunity for employees to take vacation during the year
• The type of business or industry involved

In resolving disputes over vested vacation, the Labor Commissioner is to apply principles of equity and fairness.11

Many employers impose caps at 1.5 or 2 times the annual accrual rate, for example, 60 or 80 hours for an employer granting 40 hours of vacation per year. An employee must have a reasonable amount of time after the accrual to take the time before a cap is imposed. The DLSE has repeatedly found that vacation policies that require vacation to be taken in the year earned, or in a very limited period after the accrual period, are unfair.12 For example, if you capped vacation earnings at the same amount accrued in one year, it would not be reasonable.

Examples of How Caps Work

The following situations are examples of vacation policies with caps. A low cap is not valid unless the employee is free to use vacation as it is earned.

Examples include:

• XYZ company offers 40 hours of vacation per year. There is a 60-hour cap on vacation accrual. Eddie started working for the company on January 1, 2017. He began accruing vacation immediately. He did not take any vacation in 2017. Eddie accrued 40 hours of vacation in 2017.

Eddie continued accruing vacation in 2018 until June 30, when he hit the 60-hour cap. He did not accrue any vacation in July, August or September. He finally took a week off from October 1 through October 7 in 2018. He did not begin accruing vacation again until October 1, 2018, when he began his first vacation. XYZ was not required to retroactively give Eddie the vacation he otherwise would have earned in July, August and September. Eddie lost the opportunity to earn vacation during those months because he already reached the cap. However, at no time did the company violate the rule against use it or lose it policies.

• ABC Company offers 40 hours of vacation per year. There is an 80-hour cap on vacation accrual. Wilma started working for the company on January 1, 2016. She began accruing vacation immediately. Wilma was ineligible to take any vacation in 2016 under ABC Company's policy, because she had not completed a year of service. Wilma accrued 40 hours of vacation in 2016 and continued accruing vacation in 2017, never reaching the 80-hour cap.

She took a week off from October 1 through October 7, 2017, reducing her vacation bank. Wilma continued earning vacation in 2017 and 2018 until she reached the 80-hour cap.

Cash-Out Policies Allowed

You can choose to offer your employees the option to cash out their vacation benefits. You can offer this option on an as needed basis or allow it only at certain times, such as at the end of the year. You can require employees to accept pay each year for vacation time that they accrued but did not take, instead of carrying vacation time over from one year to the next. The cash out of vacation time must be at the employee’s current pay rate.13

Vacation Taken Before it Is Earned

Because of schedules and employee needs, you may allow employees to take vacation before they actually accrue it. Because the time is a form of wages, this practice is, in effect, a loan against future wages. If employment terminates before the vacation is earned, you will not be able to recover the advanced vacation wages by a paycheck deduction. For more information, see Employee Debts, Loans and Deductions. To avoid issues of recovering an advance, you can create a policy that prohibits employees from taking vacation before they have earned or accrued it.

Requiring Advance Notice of Vacation

Company policy can require employees to give notice before taking vacation days. If an employee fails to report to work and then declares the missed day as a vacation day, you need not pay the employee for the claimed day. You are entitled to discipline the employee for failure to report to work in accordance with your policies.

• Be mindful as to whether the absence is a protected leave, such as FMLA/CFRA leave.

Pay of Accrued Vacation at Termination

Because accrued vacation is considered wages, you must pay out all accrued but unused vacation when the employment relationship ends.14 You must pay out even for an employee who had accrued vacation that they were not yet eligible to take. For example, employees may start to earn vacation immediately upon being hired, but might by company policy be required to work for one year before using any vacation time. If that employee quits after a few months, you have to pay the employee prorated vacation since it is a vested benefit.

Though you can base your vacation accrual policy on the week, pay period or some other time period, you must base computation of vested vacation benefits for a terminated employee on the employee’s daily accrual or vesting, including the final day of work. The vacation paid at the time of termination must be prorated on a daily basis and at the final rate of pay at the date of separation.

Example: An employee who is entitled to three weeks of annual vacation (15 work days entitlement per year x 8 hours/day = 120 hours vacation entitlement per year) who quits on August 7 (the 219th day of the year) without having taken any vacation during the year, who has no vacation carryover from prior years, and whose final rate of pay is $18 per hour, would be entitled to $1,296 vacation pay upon separation, calculated as follows:

• 219 days (August 7, date of quit) ÷ 365 days/year = 60 percent
• 60 percent of 120 hours vacation entitlement = 72 hours vacation earned and accrued through August 7
• Vacation days used = 0
• Vacation earned but not taken at time of separation = 72 hours
• 72 hours x $18/hour = $1,296 vacation pay due at separation

You must pay out accrued but unused vacation at the employee’s final rate of pay, regardless of the rate of pay at which it was earned.15 An employee who earned 10 hours of vacation while making $18 per hour and who is then terminated or quits while making $21 per hour, will receive $210 in vacation wages with their final paycheck. Similarly, an employee who receives a cut in pay will receive their vacation pay at the lower rate at termination. The Labor Commissioner will probably not tolerate lowering of an employee’s rate of pay just before termination to avoid paying a fair amount of earned vacation.

For more information on final pay, see Final Pay.

Employee Retirement Income Security Act (ERISA) Exemption and Vacation Plans

If your vacation plan is covered by the Employee Retirement Income Security Act (ERISA), the federal law regulating employee pension and welfare plans, the Labor Commissioner will not take employee claims relating to those plans.16 The Labor Commissioner will only take the claim if vacation is paid out of the employer's general assets and, thus, not subject to ERISA. However, the Labor Commissioner will take an employee’s claim in order to investigate whether the vacation plan is, in fact, covered by ERISA.17

Partial Day Vacations for Exempt Employees

California employers often ask how they can handle partial-day absences for exempt employees without jeopardizing the employee’s exempt status. Employers generally can’t dock an exempt employee’s salary when they’re absent from work for only part of a day. But a California employer can replace salary on an exempt employee’s partial day off by charging the time to the employee’s vested vacation or PTO bank.

California courts authorize the practice of partial day deductions from leave banks, as does California’s Labor Commissioner.

Employers can replace salary by charging the time to the employee’s vacation bank, provided the employee has enough time available when the absence occurs. It doesn't matter how many hours the exempt employee took off; the time can be deducted from an available accrued leave bank.

A 2014 decision by a California Court of Appeal reaffirmed the practice of partial-day deductions from leave banks and also emphasized that the deduction can be made in any time increment, including increments of less than four hours, without jeopardizing the employee's exempt status. An earlier case had allowed partial day deductions from leave banks, but only in four-hour increments.18

The DLSE also stated that California employers may deduct from vacation and sick leave balances for exempt employees' partial-day absences of fewer than four hours without undermining the salary basis test for purposes of overtime exemption.19 The DLSE approved the practice of allocating any amount of an exempt employee's partial-day absence to vacation, PTO or sick time.

This deduction, according to the DLSE, can be made without undermining the salary basis test for purposes of an overtime exemption.

• Employers can’t dock an exempt employee’s salary for the partial day absence; only deduct from the vacation leave bank. If the employee doesn't have enough accrued time off available when the absence occurs, they must be paid for a full day if they perform any work that day. An exception exists under the state and federal family leave laws.

Deductions should always be made in accordance with an employer’s policy. For more information, see “Limited Deductions From Salary” in Deductions From an Exempt Employee’s Salary.

Unlimited Vacation Policies

Companies with unlimited paid vacation policies operate on an honor system where employees can take time off whenever, and as often, as they like. Time off is generally not tracked and there is no accrual. The focus is on the successful completion of tasks, instead of the specific amount of time spent on a task.

There are legal risks to unlimited vacation policies in California. These risks include the following:

• Vacation accrual: Companies with unlimited paid vacation plans argue that there is no accrual and, therefore, no vesting and no vacation pay out at termination. But the California Labor Commissioner and California courts may see this as a subterfuge to avoid paying out accrued vacation. Courts may look to see what is actually going on in practice. For example, despite the company’s stated policy, is the unwritten practice really that employees are given two weeks of paid vacation? If so, it may need to be paid out just like under any other type of vacation plan.
• Unfair treatment: Unlimited paid vacation policies also may lead some employees to claim unfair or discriminatory treatment. Employees may argue that the policy is applied inconsistently. There may be problems of favoritism or, the opposite, arbitrary denials or crackdowns. If your company wants to institute an unlimited vacation policy only for your top-level exempt employees or for a certain department, you should look closely at the demographics of that particular subset of employees. Examine whether racial or gender differences exist that may be perceived as discriminatory.
• Coordination with other benefits: Unlimited paid vacation policies may conflict, or create coordination problems, with other paid and unpaid leave benefits, including mandatory paid sick leave, federal and state family and medical leave, pregnancy leave and military leave. For example, federal and state family and medical leave is unpaid, but employees can use any accrued vacation time during their leave of absence in order to receive paid time off. If there is an unlimited vacation policy, the employee could argue that they are entitled to pay for the entire 12 weeks.

A California Court of Appeal held that an employer’s supposed “unlimited” vacation policy wasn’t unlimited; it actually had an implied cap, and the employer violated the Labor Code when it failed to pay out the unused vacation.20

The court then provided guiding principles under which unlimited time off policies may be valid:

• Clearly provides that employees’ ability to take paid time off is not a form of additional wages for services performed, but perhaps part of the employer’s promise to provide a flexible work schedule — including employees’ ability to decide when and how much time to take off;
• Spells out the rights and obligations of both employee and employer and the consequences of failing to schedule time off;
• Allows sufficient opportunity for employees to actually take time off or work fewer hours in lieu of taking time off; and
• Is administered fairly so that it neither becomes a de facto “use it or lose it policy” nor results in inequities, such as where one employee works many hours and takes minimal time off while another works fewer hours and takes more time off.

Any such policy should be in writing. Although the court’s opinion doesn’t provide a bright line rule for establishing valid unlimited vacation policies, the criteria above do provide some guidance for employers on what may constitute a valid policy, depending on the facts of the case.

• There may also be other legal risks, as well as problems of abuse. Employers considering implementing unlimited vacation policies should consult legal counsel.

Sabbatical Versus Vacation

In Paton v. Advanced Micro Devices, Inc., a California Court of Appeal evaluated the differences between paid sabbaticals and regular paid vacations. The distinction is important for California employers, who typically do not pay an employee for an unused sabbatical upon termination.21

Advanced Micro Devices (AMD) established a sabbatical program as an employee benefit. All full-time, salaried employees were eligible for an eight-week paid sabbatical after seven years of service. Employees had to demonstrate achievement of certain performance standards. The purpose of the sabbatical was “time away from work for enrichment and revitalization.” Employees were not expected to pursue any work-related study or other activities during the sabbatical.

AMD’s policy stated that the sabbatical benefit would forfeit upon termination of employment. The sabbatical program was in addition to AMD’s regular vacation benefit.

Plaintiff Paton worked for AMD for approximately eight years. When Paton resigned, AMD refused to pay him for the unused eight-week sabbatical in his final paycheck. Paton filed a claim for nonpayment of wages.

Four Factors Create a Sabbatical

The court determined that vacation “is paid time off that accrues in proportion to the length of the employee's service, is not conditioned upon the occurrence of any event or condition, and usually does not impose conditions upon the employee's use of the time away from work.” The court also noted that a vacation benefit is not an inducement to remain employed, in contrast with a bonus or stock options.

The court then went on to identify four factors that will distinguish a sabbatical from a vacation:

• Sabbaticals are granted infrequently, such as after seven years of service, as an inducement to employees to keep their jobs.
• The duration of the sabbatical should be sufficient to achieve its purpose. When the sabbatical is “unconditional” — for the purpose of re-energizing the employee — the sabbatical should be longer than a normal vacation period.
• A sabbatical will always be longer than an employee's regular vacation entitlement. Additionally, the “regular vacation” period should be comparable to that offered in the industry, since employers could otherwise offer an extremely short “vacation” period as a counterpoint to a two-week sabbatical.
• Since a sabbatical is a benefit designed to retain employees, the employee taking a sabbatical should be expected to return to work at its conclusion.

The court concluded that there was insufficient evidence to demonstrate clearly whether AMD’s eight-week absence was a sabbatical or a vacation. Employees at AMD could accrue up to eight weeks in vacation time, so the sabbatical was not for a significantly longer duration. Additionally, neither party presented evidence of common vacation accruals in AMD’s industry. Consequently, the court referred the case back to the trial court to weigh the four specific factors in light of AMD’s actual policy.

• If you currently offer employees a sabbatical program, or are considering offering sabbaticals as an inducement to continued employment, consult with legal counsel to ensure compliance with the four factors set out by the Paton court.

For more information on sabbaticals, see Sabbatical.

Rules for Providing Vacation

California law does not require employers to provide vacation. However, if you offer these benefits, you must follow specific rules:

• Vacation is considered wages. They must be earned and vested as the employee works. For example, if the accrual rate you set for vacation is two work weeks (ten days) per year, after six months the employee will have earned one work week (five days) of vacation.
• Vacation pay accrues as earned and cannot be forfeited even when the employment relationship ends, regardless of the reason.
• Although you can place a reasonable cap on vacation accrual, you must give employees a reasonable amount of time to use vacation before they stop accruing time.
• Accrued vacation is paid out at termination at the employee’s final rate of pay, not at the rate in effect when the employee accrued the vacation.22
• You determine at what point the employee begins to earn vacation. For example, you might set a policy that an employee cannot begin to earn vacation until after the first month, three months or six months of employment.
• The accrual rate cannot decelerate. You cannot designate an accrual rate of two weeks after six months of employment and two weeks after the following year. This plan creates a deceleration of accrual. The employee earns no vacation during the first six months, accrues vacation at the rate of 1.66 days per month during the second six months of employment, then accrues 0.833 days per month during the second year.

• If you fail to pay out accrued and unused vacation wages at termination, employees can file a wage and hour claim with the Labor Commissioner or in superior court. If the employee wins, they can collect a waiting time penalty of one day’s wages for every day that the wages were unpaid, up to 30 days. Additionally, at the time of termination the employee would have a claim for any unpaid vacation wages accrued during their employment.

Use of Vacation During Leaves of Absence

Employees can use vacation during other forms of protected leave. The following sections illustrate the requirements California law creates for the use of vacation during some types of leaves.

Using Vacation During Pregnancy Disability Leave (PDL)

You cannot require an employee to use vacation during a pregnancy disability leave (PDL) absence. You must permit an employee to use vacation during PDL if the employee requests to use the benefit during the PDL. The employee makes the choice of whether or not to use vacation.

However, the employee must meet any eligibility requirements set by your vacation policy or practice before being able to use vacation during a PDL absence.

Using Vacation During FMLA or CFRA

You can require an employee to use vacation during some Family and Medical Leave Act (FMLA) or California Family Rights Act (CFRA) absences that are not related to pregnancy disability. Include these requirements in your employee handbook. For more information, see Pay and Benefits During Family and Medical Leave.

• If the employee takes leave under the FMLA and the employee receives disability benefits, such as State Disability Insurance (SDI), workers' compensation benefits or other types of disability benefits, you cannot require the employee to use vacation benefits during the portion of leave when they are receiving these disability benefits.

Communicating Vacation Policies to Employees

Include the following information in your employee handbook or written policies:

• The time period during which accrual begins for new hires, the rate of accrual and any incremental increases in accrual, such as for more years of service.
• Any eligibility requirements or restrictions on the use of vacation and any required use, including during a leave of absence.
• Any requirements that vacation be requested in advance, in writing or be approved by a supervisor or other individual.
• The form or other documentation required to report vacation.

If you do not plan to advance vacation time that has not yet been earned, notify the employee that they cannot take more vacation until it has accrued. You should regularly reconcile an employee’s vacation accruals with time they’ve taken, and send written notice advising employees of the amount of accrued time remaining for vacation.

If you advance vacation, the vacation is not considered an employee debt. You cannot deduct the money from the employee’s wages later, even if they’ve accrued enough time off to pay back the advance.23

You must pay out any accrued, unused vacation at the time of termination.

Vacation Policy Best Practices

• Create a clear vacation policy and provide employees with a copy of the policy.
• Do not create unreasonable caps on how much vacation can be earned.
• Do not institute a “use it or lose it” vacation policy.
• These same rules will apply to PTO policies.

• CalChamber’s Employee Handbook Creator ® can help you easily create an employee handbook that contains this policy. Purchase at the CalChamber store.

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1. DLSE Enforcement Policies and Interpretations Manual sec. 15.1.2