Tax withholding on an unused leave payout works differently from your regular paycheck. The IRS treats the payment as supplemental wages, so your employer will either withhold a flat 22% for federal income tax or add the payout to your regular wages and run the combined amount through standard withholding tables. Either way, Social Security tax at 6.2% and Medicare tax at 1.45% also come out, just as on any paycheck. Which federal method your employer picks can meaningfully change the cash you take home, and it catches a lot of departing employees off guard.
Why the Payout Is Taxed Differently
IRS Publication 15 classifies lump-sum payments for unused vacation and accumulated sick leave as supplemental wages, the same category as bonuses, commissions, severance, and back pay.1Internal Revenue Service. Publication 15 Employer’s Tax Guide The category exists because regular payroll tables assume a steady salary repeating every pay period. Running a $6,000 leave payout through those tables without adjustment would treat you as though you earn that inflated amount every two weeks all year, producing wildly excessive withholding. The supplemental wage rules give employers two cleaner options.
The Flat 22% Method
Under the flat-rate method (also called the percentage method), your employer withholds exactly 22% of the leave payout for federal income tax. Your W-4 filing status, dependents, and other adjustments are ignored. A $4,000 vacation payout produces $880 in federal withholding, full stop.1Internal Revenue Service. Publication 15 Employer’s Tax Guide
The 22% figure was locked in permanently by the legislation that extended the individual tax rates originally set by the Tax Cuts and Jobs Act, so the earlier uncertainty about a post-2025 reversion no longer applies.2Internal Revenue Service. Publication 15 Employer’s Tax Guide
One exception can raise the rate. If your employer has paid you more than $1 million in supplemental wages during the calendar year, every dollar above that threshold is withheld at 37%.3eCFR. 26 CFR 31.3402(g)-1 – Supplemental Wage Payments For someone cashing out a few weeks of vacation, this is irrelevant. It mainly hits executives with very large bonus packages.
The Aggregate Method
The second option often withholds more. Your employer adds the leave payout to your regular wages for the current pay period and runs the combined amount through the standard withholding tables in IRS Publication 15-T as though it were one paycheck.1Internal Revenue Service. Publication 15 Employer’s Tax Guide After computing tax on that inflated figure, the employer subtracts the tax already withheld from your regular wages. The remainder is pulled from the leave payout.
Here’s why it stings. Say you earn $2,000 every two weeks and receive a $5,000 vacation payout on the same check. The system sees $7,000 for that pay period and annualizes it: $7,000 × 26 = $182,000. For a single filer in 2026, that pushes part of your income into the 24% bracket even if your actual salary is around $52,000.4Internal Revenue Service. Publication 15-T Federal Income Tax Withholding Methods The tables don’t know this is a one-time event. They withhold as if $182,000 is your real annual income.
The money isn’t gone. Any excess withholding shows up as a refund credit when you file your return. But less cash lands in your pocket now, which matters if you’re between jobs.
Social Security and Medicare
FICA taxes apply to leave payouts too, and there’s no election here. Social Security tax hits at 6.2% on earnings up to the annual wage base, which is $184,500 for 2026.5Social Security Administration. Contribution and Benefit Base If your year-to-date earnings have already exceeded that cap by the time the payout hits, no additional Social Security tax comes out of it. Otherwise, 6.2% applies to whatever portion of the payout keeps you under $184,500.
Medicare tax is a flat 1.45% on all wages with no cap.6Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates If your total compensation for the year exceeds $200,000, an additional 0.9% Medicare surtax kicks in on everything above that threshold.7Internal Revenue Service. Topic No. 560, Additional Medicare Tax The $200,000 trigger applies regardless of filing status for withholding, though the actual liability on your return varies. Married couples filing jointly don’t owe the surtax until combined wages pass $250,000.
State Withholding
Federal is only part of it. Most states with an income tax also require withholding on supplemental wages, and many have their own flat rates for these payments. Rates range widely, from around 1.5% in lower-tax states to more than 11% in the highest-tax states. Some states require the aggregate method rather than offering a flat option, which reproduces the same inflated-paycheck math at the state level.
A handful of states have no income tax at all, so no state withholding comes out. If you’re in a state that does tax income, check your final pay stub. The state supplemental line is easy to miss when you’re focused on the federal number.
Getting Over-Withholding Back
If the aggregate method pushed withholding above your actual tax liability, you’ll recover the difference when you file Form 1040. The IRS compares what you owe based on your real annual income against total tax withheld from all your paychecks. Any overpayment comes back as a refund.
There’s no separate form or extra step for leave payout over-withholding. It flows through the same reconciliation as everything else. If you got the payout early in the year and started a new job, you can file an updated W-4 with your new employer to reduce withholding and even things out sooner instead of waiting until April.
The 22% flat rate often lands close to what a middle-income earner actually owes, so refund surprises under that method tend to be modest. The aggregate method is where the big over-withholding happens, especially on a large payout combined with a final regular paycheck.
Routing the Payout Into a 401(k)
Some employers let you direct the value of unused paid time off into a 401(k) plan instead of taking cash. The IRS approved this arrangement in Revenue Ruling 2009-31, provided the plan is structured correctly and the contribution stays within the annual deferral limit.8Internal Revenue Service. Revenue Ruling 2009-31 With a valid advance election, the contribution counts as an elective deferral, treated like any other 401(k) contribution from a paycheck.
Two catches. Your employer’s plan has to specifically allow it, and most don’t. And the contribution still counts toward your annual 401(k) limit, so check how much room you have left. If you’ve already maxed out deferrals, routing the payout into the plan creates an excess contribution problem. Where the option exists and there’s room, it’s a clean way to shelter the payout from immediate income tax while adding to retirement savings.
No Federal Law Requires the Payout
Before planning around the tax, confirm you’re getting the money. No federal law requires your employer to pay you for unused vacation or sick time when you leave. The Fair Labor Standards Act does not require payment for time not worked, including vacation and sick leave.9U.S. Department of Labor. Vacation Leave Whether you receive a payout depends on your employer’s written policy, your employment contract, or state law.
Many states require employers to pay out accrued vacation at termination, but the rules vary. Some require payment on your last day, others allow until the next regular payday, and some leave it to company policy. Sick leave payouts are required even less often. If your employee handbook says unused leave is forfeited upon separation, that policy may be enforceable depending on where you work. Read the fine print before building a tax strategy around money you might not receive.