A PTO policy is the written rule for how employees earn, book and get paid for paid time off. US federal law doesn't require paid vacation at all, so your policy is the agreement that governs it. Once you offer PTO, though, state law can control the details: in California, earned vacation counts as wages, so you can cap accrual but can't make it expire.
That combination, no federal requirement but strict state rules once you've promised it, is why PTO policies cause so many disputes. The wording you choose decides what you owe when someone leaves.
What federal law says
The Department of Labor's position is short. The Fair Labor Standards Act doesn't require payment for time not worked, such as vacations, sick leave or federal or other holidays. These benefits are matters of agreement between an employer and an employee, or their representative.
There's one federal exception for government contractors. As of October 2026, the DOL notes that on contracts covered by the McNamara-O'Hara Service Contract Act that exceed $2,500, holiday and vacation fringe benefit requirements are set out in the contract's wage determination.
Where state law steps in: California's rules
California is the clearest example of a state that regulates PTO once you offer it. Its Labor Commissioner says there's no legal requirement to provide paid or unpaid vacation, but if you do, earned vacation is treated as wages that vest as they're earned. That leads to five rules worth knowing even if you're not in California, because other states borrow the same logic:
| Policy feature | California's position | What it means |
|---|---|---|
| Use it or lose it | Illegal | Earned vacation can't be forfeited by a deadline |
| Accrual cap | Allowed | You can stop accrual at a ceiling (the Labor Commissioner's example is 200 hours) until the balance falls |
| Waiting period | Allowed, if real | No vacation may be earned in, say, the first year, as long as it isn't a disguised accrual |
| Excluding some staff | Allowed | Part-time, temporary or probationary staff can be excluded if the policy says so clearly |
| Pay on leaving | Required | Unused vacation is prorated daily and paid at the final rate of pay |
Here's the sourced insight most policy templates get wrong: a cap and an expiry look similar but are treated completely differently. A 'use it or lose it' rule takes away pay someone has already earned. A cap simply stops them earning more until they take some time off. One is illegal in California; the other is a normal policy tool.
Types of PTO policy
| Type | How it works | Watch out for |
|---|---|---|
| Accrual | Employees earn a set amount each pay period | Track balances accurately; state payout rules may apply when they leave |
| Front-loaded | The full year's allowance is granted at the start of the year | Decide what happens if someone leaves early in the year |
| Separate buckets | Vacation, sick and personal days are separate | Sick leave may be governed by its own state or city laws |
| Combined PTO bank | One pool for every kind of time off | Check how your state treats a combined bank when someone leaves |
| Unlimited | No fixed allowance, time off by agreement | Make clear whether anything accrues, or you may owe a payout |
How to write a PTO policy: an outline
- Who's eligible: which employees, and any waiting period.
- How PTO is earned: the accrual rate or the front-loaded amount, and any cap.
- How to request it: notice needed, who approves, and how conflicts are handled.
- Carryover: whether unused time rolls over, and up to what limit (check state rules before adding any expiry).
- Holidays: which public holidays are paid, if any, and how they interact with PTO.
- Sick time: whether it's part of PTO or separate, and how it meets any local sick leave law.
- Leaving the business: what happens to unused balances, written to match the strictest state where you employ people.
- Records: where balances are shown, and who to ask when something looks wrong.
A tracking tool makes accrual and caps much easier to run; our roundup of PTO trackers compares the options. For specific leave types, see our guides to bereavement leave and the FMLA, which sets job-protected unpaid leave alongside your PTO.
Common PTO policy mistakes
- Copying a template from another state with an expiry clause that's void where you operate.
- Calling something 'unlimited' while quietly tracking balances, which can make the time look earned.
- Leaving part-time staff out in practice but not in writing.
- Letting managers approve requests by different rules, so similar staff get different treatment.
- Never telling people their balance, so disputes only surface on the last day.
Payout when someone leaves
This is where a vague policy costs most. In California, unused vacation must be paid out at separation, calculated daily and at the final rate of pay. The Labor Commissioner's example shows someone entitled to 120 hours a year who leaves after earning 60% of it: they're owed 72 hours. Other states take different approaches, and some follow whatever your written policy says. That's the strongest reason to write the payout rule down clearly.
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The verdict
Write the policy before you need it, and write it for the strictest state where you employ people. Use a cap rather than an expiry date, say plainly who's excluded, and spell out what happens to unused PTO at the end of employment. Federal law may not require paid time off, but once you promise it, your policy is the law of your workplace.
Frequently asked questions
Is PTO required by federal law?
No. The Department of Labor says the Fair Labor Standards Act doesn't require payment for time not worked, such as vacations, sick leave or holidays. It's a matter of agreement between employer and employee.
Is use it or lose it PTO legal?
It depends on the state. In California it's illegal, because earned vacation is treated as wages that vest as they're earned, but capping how much can accrue is allowed.
Do employers have to pay out unused PTO?
Some states require it. In California, unused vacation must be paid at separation, prorated daily at the final rate of pay. Elsewhere the written policy often decides.
What should a PTO policy include?
Eligibility, how PTO is earned and any cap, how to request it, carryover, holidays, how sick time is handled, what happens to unused balances when someone leaves, and where records are kept.
