As employees start requesting time off for Thanksgiving, Christmas, and New Year’s, it’s a good time for California employers to revisit the state’s unusual rules on vacation and paid time off (PTO). California does not require employers to offer paid vacation at all, but once an employer does, the benefit is treated as earned wages and is tightly regulated under Labor Code section 227.3 and the California Supreme Court’s decision in Suastez v. Plastic Dress-Up Co. (1982).
This year’s update matters for one reason in particular: a new law signed on September 30, 2026 changes how employers can handle PTO advanced to employees who later quit, starting January 1, 2027 — right in the middle of the holiday season. Here are five vacation issues California employers should have on their radar this December.
1. “Use-it-or-lose-it” policies are still prohibited — and “PTO” or “unlimited” labels don’t change that.
Under California law, vacation vests as the employee works, so an employee cannot be required to forfeit vacation that has already been earned. A policy that wipes out unused balances on December 31 (or before the holidays) is unlawful.
Two common workarounds don’t avoid the rule:
- Combined PTO plans. The Labor Commissioner treats a PTO bank that can be used for any purpose — vacation, sick time, or personal days — as vacation. PTO vests daily, cannot be forfeited, and must be paid out at separation. (Standalone paid sick leave under Labor Code section 246 generally does not have to be paid out, but once sick time is folded into a general PTO bank, it is treated like vacation.)
- “Unlimited” vacation. In McPherson v. EF Intercultural Foundation, Inc. (2020), the Court of Appeal held that an informal “unlimited” policy that was not unlimited in practice was subject to section 227.3, and the employer owed vacation payouts. The court did not hold that truly unlimited policies are unlawful, but an unwritten or loosely administered policy is risky.
If the goal is to keep balances from growing year after year, there are lawful options: a reasonable accrual cap (Point 2) or an annual cash-out of unused vacation, which the Labor Commissioner has recognized as permissible.
2. Reasonable caps — and holiday scheduling — are your management tools.
Employers may adopt a “no additional accrual” cap: once an employee’s balance reaches a set ceiling, no more vacation accrues until the employee uses some of it. The cap must be reasonable, and it must be clearly described in the written policy.
What counts as “reasonable”? There is no statutory number. The DLSE previously took the position that a cap of 1.75 times the annual accrual was appropriate, but it later withdrew that opinion. Many employers now set caps between 1.5 and 2 times annual accrual. The Labor Commissioner’s guidance also states that employees should have at least nine months after vacation accrues to use it before a cap takes effect. A cap equal to one year’s accrual will usually be treated as a disguised use-it-or-lose-it policy.
Employers also have more control over when vacation is taken than many realize. The Labor Commissioner recognizes that employers may decide when vacation can be used and how much can be taken at one time. That means an employer can generally:
- Set blackout periods during the busiest weeks of the holiday season;
- Limit the number of employees off at the same time; and
- Schedule a year-end closure and require employees to use accrued vacation during it, provided the policy is clear and employees receive reasonable advance notice.
3. Accrued vacation must be paid out when employment ends — including during seasonal furloughs.
Earned, unused vacation must be paid at the employee’s final rate of pay as part of the final paycheck under Labor Code sections 201, 202, and 227.3. Missing the deadline can trigger waiting time penalties under Labor Code section 203 of up to 30 days of wages.
For restaurants, hotels, retailers, and other employers that adjust staffing after the holidays, the timing rule is a trap. In Hartstein v. Hyatt Corp. (9th Cir. 2023), the Ninth Circuit agreed with the Labor Commissioner that a temporary layoff or furlough without a specific return date within the normal pay period is a “discharge,” so all final wages — including accrued vacation — are due immediately. What the employer calls the separation doesn’t matter.
If you plan a January slowdown, either give employees a firm return date within the same pay period or be prepared to issue final pay, including vacation, on the day the furlough begins. (For more on getting final pay right, see our post, Key Issues Every California Employer Must Get Right When Terminating an Employee.)
4. Negative balances still cannot be deducted from final pay — but a new repayment option arrives January 1, 2027.
The holidays are when employees most often ask to borrow against vacation they haven’t earned yet. The Labor Commissioner treats advanced vacation as an advance of wages. If the employee leaves before earning it back, the employer cannot deduct the negative balance from the final paycheck. Self-help recovery from final wages is unlawful under Barnhill v. Robert Saunders & Co. (1981), and the deduction can also lead to waiting time penalties.
What’s new is that California’s “stay-or-pay” law now creates a narrow path to recover some advanced PTO. AB 692, enacted in 2025, generally bars employment contracts that require workers to repay money when their employment ends. On September 30, 2026, Governor Newsom signed AB 1697, which delayed AB 692 so it applies only to contracts entered into on or after January 1, 2027. AB 1697 also added an exception for repaying advanced PTO if all of the following conditions are met:
- The employee voluntarily separates (the exception does not apply when the employer ends the relationship);
- The repayment terms are clearly disclosed in writing, separate from the primary employment contract, at the time the employee requests the advance;
- The repayment obligation does not exceed 40 hours of PTO; and
- No interest accrues.
Two cautions. First, the exception permits a repayment obligation. It does not authorize an automatic deduction from final wages, so the Barnhill rule still applies and recovery must come through a voluntary repayment or a separate collection effort. Second, any repayment arrangement for advances above 40 hours, or one that doesn’t meet each condition, risks violating the stay-or-pay statute once it takes effect, with exposure of actual damages or $5,000 per worker (whichever is greater), plus attorney’s fees.
Practically, employers that allow vacation advances should update their advance-request form before January 1 so that any request made in the new year includes the separate written disclosure. Many employers will decide that simply capping advances at 40 hours is the cleanest approach.
5. Waiting periods are lawful; disguised “cliff vesting” is not.
Employers may adopt a waiting period at the start of employment during which no vacation is earned. California courts have upheld waiting periods of six months and even one year when the policy is clear. Owen v. Macy’s, Inc. (2009); Minnick v. Automotive Creations, Inc. (2017). An employee who leaves during a valid waiting period is not owed vacation pay.
The risk comes when a policy looks like a waiting period but actually rewards the waiting period after the fact. The Labor Commissioner will treat a plan as a “subterfuge” if the first post-waiting-period grant is inflated to make up for the waiting period — for example, no vacation in year one, four weeks in year two, and two weeks in year three. In that situation, the Labor Commissioner treats the vacation as having been earned during year one, and employees who leave early are owed prorated vacation at their final rate.
The safer formulation is a clearly worded policy stating that no vacation is earned or accrues during the waiting period, followed by accrual that begins after the waiting period ends and does not “catch up” for the time already worked.
California’s vacation rules are stricter than federal law and those of most other states, and the holidays are when they get tested — advance requests, year-end balances, shutdowns, and post-season staffing changes all land at once. (Remember, too, that California does not require holiday pay or premium pay for working on a holiday, unless the employer’s own policy promises it.) A quick review of your vacation policy, cap language, and advance-request forms now can prevent costly wage claims in the new year. For a broader overview of these rules, see our earlier post, Navigating California’s Unique Vacation Laws.
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