Vacation payout is taxed as supplemental wages. That means your employer withholds federal income tax at a flat 22%, or uses an aggregate calculation that often withholds more, and layers Social Security (6.2%) and Medicare (1.45%) on top. Roughly 30% of the check tends to disappear before you see it, and that’s before any state tax. The withholding is an estimate; your actual tax gets settled when you file your return.
Why the IRS Treats It as Supplemental Wages
IRS Publication 15 draws a line between regular vacation pay and a lump-sum payout. If you take a week off and get your normal paycheck, that’s regular wages. When your employer pays you a lump sum for unused leave you never took, Publication 15 says to “treat it as a supplemental wage payment.”1Internal Revenue Service. Publication 15 (2026), (Circular E), Employer’s Tax Guide
Supplemental wages include bonuses, commissions, overtime, severance, back pay, and accumulated leave payouts. What ties them together is that they sit outside the regular payroll cycle. Your employer can’t just run the payout through ordinary payroll math; it has to pick one of two IRS-approved withholding methods, and both usually take a bigger bite than a normal paycheck.
The Two Federal Withholding Methods
Employers choose between two approaches for federal income tax on a supplemental payment. Both come from Publication 15.1Internal Revenue Service. Publication 15 (2026), (Circular E), Employer’s Tax Guide
Flat 22% Method
The simpler option is a flat 22% on the entire supplemental payment. A $5,000 vacation payout means exactly $1,100 goes to the IRS. No other percentage is allowed under this method, and it applies regardless of your normal tax bracket (as long as your total supplemental wages stay under $1 million for the year).
Most payroll departments prefer this approach because the math is simple and the risk of under-withholding is low. For someone in the 10% or 12% bracket, 22% feels steep. For someone in a higher bracket, it may not be enough, and a balance can be due at tax time.
Aggregate Method
Under the aggregate method, the employer adds your vacation payout to your regular wages for the current pay period, then withholds as if you earned that combined amount every pay period all year. A $5,000 payout stacked on top of a $2,000 biweekly paycheck makes it look like you earn $182,000 a year, and payroll software withholds at the rate that fits that inflated figure.
This method frequently over-withholds because the calculation pretends you’ll earn that combined amount for 12 months, which you won’t. The excess comes back as a refund when you file, but in the meantime the final check can look alarmingly small.
Payouts Over $1 Million
If your total supplemental wages from one employer top $1 million in a calendar year, every dollar above that threshold is withheld at 37%, the top individual rate.1Internal Revenue Service. Publication 15 (2026), (Circular E), Employer’s Tax Guide Vacation payout alone rarely triggers this, but it can matter when a big severance, bonuses, and unused leave all land in the same year.
Social Security and Medicare on Top
Federal income tax is only part of the deduction. FICA taxes come out too, regardless of which withholding method your employer chose.
- Social Security: 6.2% of the payout, up to the annual wage base of $184,500 for 2026. If your earlier wages already pushed you past that cap, no more Social Security tax is owed.2Social Security Administration. Contribution and Benefit Base
- Medicare: 1.45% on the full amount, with no earnings cap.3Office of the Law Revision Counsel. 26 USC 3101 – Rate of Tax
- Additional Medicare Tax: an extra 0.9% kicks in once your total wages for the year exceed $200,000 (single) or $250,000 (married filing jointly). If the payout pushes you over the line, your employer withholds it on the excess.4Internal Revenue Service. Questions and Answers for the Additional Medicare Tax
On a $10,000 payout for someone still below the Social Security wage base, expect about $620 for Social Security and $145 for Medicare. Add the 22% federal withholding and roughly $2,965 is gone before any state tax. FUTA (federal unemployment) is paid entirely by the employer and doesn’t come out of your check.
State and Local Taxes
Most states with an income tax also withhold from a vacation payout. Some apply their own flat supplemental rate; others require the aggregate method at the state level. A handful of states have no income tax, which makes the payout land softer. The rate and method depend on where you work, and sometimes where you live, so check your state’s withholding guidelines if you want to estimate the net accurately.
What Happens When You File
The withholding on a vacation payout is an estimate, not the final bill. When you file Form 1040, you calculate actual tax based on all income for the year and subtract everything withheld. If 22% came out of the payout but your effective rate for the year turns out to be 15%, the difference comes back as a refund.
The reverse also happens. Someone in the 24% or 32% bracket may find the flat 22% wasn’t enough and end up owing in April. That’s especially common when a big payout stacks on top of a full year of high wages, investment income, or a spouse’s earnings.
Your W-2 folds the payout into total wages (Box 1) and total federal tax withheld (Box 2). Nothing breaks out the supplemental portion separately, so keep your final pay stub if you want to see the payout’s exact contribution to those numbers. That stub is also useful for confirming FICA was calculated correctly if you were near the Social Security wage base.2Social Security Administration. Contribution and Benefit Base
Ways to Soften the Hit
You can’t dodge tax on a vacation payout, but timing and pre-tax contributions can help.
If you have any say in when you leave, receiving the payout in a year when your overall income is lower reduces the effective rate you’ll pay at filing. Someone who works only part of the year and then separates typically ends up in a lower bracket than someone getting the same payout on top of a full year of salary. Withholding may still be 22%, but the refund at filing will be larger.
Maxing out pre-tax retirement contributions in the year of the payout also helps. Every dollar routed into a traditional 401(k) reduces taxable income. If your employer lets you adjust your contribution percentage on your final paycheck, raising it can offset some of the payout’s tax impact. The same logic applies to a health savings account if you’re enrolled in a qualifying plan.
One thing that doesn’t work: asking your employer to split the payout across two calendar years. The IRS requires the payment to be treated as income in the year it’s paid, and most employers won’t delay part of a final paycheck. It hits the year you actually receive it.
Whether You’re Owed a Payout at All
Before worrying about tax math, confirm your employer actually owes you anything. There’s no federal law requiring a vacation payout. Roughly 20 states require employers to pay out accrued, unused vacation when employment ends, though several of those let employers avoid the rule with a clear written policy. A smaller group prohibits “use-it-or-lose-it” policies entirely. In the remaining states, payout comes down to whatever the handbook, contract, or established practice says. In states that treat accrued vacation as earned wages, a forfeiture clause in the handbook may not survive a challenge.