Is Annual Leave Taxed? Payout Rules In Australia

Annual leave payments are a regular part of running payroll, but they can get tricky when an employee cashes out leave or leaves your business. As an employer, your job is to classify the payment correctly, apply the right PAYG withholding treatment, check whether leave loading applies, and pay final entitlements on time.

If you're managing annual leave payments, it's important to understand how they usually work from an employer compliance perspective. These rules help you process payroll correctly, keep clear records and answer employee questions confidently. If an employee has questions about their own tax outcome, you can direct them to the ATO or their accountant.

Is Annual Leave Taxed In Australia?

Yes. Annual leave payments are taxable income for employees, so you generally need to withhold PAYG amounts through payroll. The exact payroll treatment depends on whether the employee is taking annual leave, cashing out leave while still employed, or receiving unused annual leave in their final pay.

Annual leave taken during employment: usually paid at the employee's base rate for ordinary hours and taxed through PAYG withholding like regular wages.
Annual leave cashed out during employment: generally taxed as ordinary earnings in the pay cycle it's paid.
Unused annual leave paid on resignation or termination: taxable, but handled as an unused leave payment, not an Employment Termination Payment.
Leave loading: taxable when paid, whether it's paid during leave, on cash-out, or on termination if the employee is entitled to it.

Your payroll treatment can be affected by the reason employment ended, the timing of the leave accrual, and the type of payment being made. A payroll provider, accountant or the ATO can confirm the correct withholding method for the specific payment your business is processing.

What Is Annual Leave Payment?

Annual leave payment is the amount you pay an employee for accrued annual leave. It can arise when the employee takes time off, when annual leave is cashed out by agreement, or when unused annual leave is paid out at the end of employment.

Under the National Employment Standards in the Fair Work Act 2009, most full-time and part-time employees accrue four weeks of paid annual leave each year, based on their ordinary hours of work. Some shiftworkers are entitled to five weeks. Casual employees generally don't accrue paid annual leave because their casual loading is intended to compensate for certain paid leave entitlements they don't receive.

How Annual Leave Is Paid During Time Off

When an employee takes annual leave, you pay their base pay rate for the ordinary hours they would have worked during that leave period.
If the employee is entitled to leave loading under a Modern Award, enterprise agreement or contract, you add that loading when the leave is paid. You can read more about Annual Leave Loading and how it works in practice.
Superannuation guarantee is generally payable on paid annual leave taken during employment because it forms part of ordinary time earnings. The super guarantee rate is 12% from 1 July 2025.

Agreements, Awards And Enterprise Agreements

The NES sets the minimum standard, but a Modern Award, enterprise agreement or Employment Contract can add important details. These might include leave loading, how leave requests are approved, shutdown directions, whether annual leave can be cashed out, and how much notice an employee needs to give before taking leave.

If more than one source seems to apply, you should identify the relevant industrial instrument and make sure the employee receives at least their minimum legal entitlement. This is especially important where your business has different employees covered by different awards, agreements or contracts.

What Happens To Annual Leave When Employment Ends?

When employment ends, accrued but unused annual leave must be paid out in the employee's final pay. This applies whether the employee resigns, is dismissed, is made redundant, or their employment ends for another reason.

The payout must include annual leave loading if the employee would have received it when taking annual leave during employment. This can apply even if an award, enterprise agreement or contract says loading isn't paid on termination, so employers should check the relevant instrument carefully. For timing and breakdowns, see our guide to Calculating Final Pay.

Annual Leave Payout On Resignation

On resignation, unused annual leave is taxable and is generally paid as part of final pay. It isn't an Employment Termination Payment. You should report it separately through payroll as an unused leave payment and apply the ATO withholding method for unused annual leave on termination.

If an award, enterprise agreement or employment contract sets a final pay deadline, you must follow it. Some awards require final pay within a set period, such as seven days after employment ends. If there's no specific deadline, you should pay final entitlements promptly, usually in the next normal pay cycle.

Annual Leave Payout On Redundancy

Unused annual leave is also paid out on redundancy. A genuine redundancy may have separate tax rules for redundancy payments, but unused annual leave is still dealt with under the unused leave rules. You shouldn't roll the annual leave payout into an ETP or the tax-free redundancy component.

If you're handling redundancies, notice and severance calculations can become complex, especially where awards or enterprise agreements apply. The redundancy pay calculator can help you get an initial view before checking the relevant industrial instrument and payroll settings.

What About Super On Unused Annual Leave Paid Out?

Superannuation is generally not payable on unused annual leave paid out when employment ends, because it isn't treated as ordinary time earnings. For context on termination payments and super, see our guide: Do You Pay Superannuation On Termination Payments?

Why Can Annual Leave Payouts Look Heavily Taxed?

Sometimes more tax is withheld upfront from a larger annual leave payment, but that doesn't always mean the employee pays more tax overall. The employee's final tax position is worked out through their tax return based on their total income, deductions and tax offsets for the financial year.

From your side as an employer, the key point is to withhold correctly rather than advise the employee on their personal tax position. If an employee is concerned about the amount withheld, you can explain how the payment was categorised in payroll and suggest they contact the ATO or their accountant for personal tax guidance.

Worked Example: Annual Leave Payout On Resignation

Say Maya resigns from a full-time role in your business. Her base salary is $80,000 per year, and she has three weeks of unused annual leave. Her weekly base rate is approximately $1,538.46, so three weeks of unused annual leave is $4,615.38 before tax.

If Maya's award also provides 17.5% annual leave loading, the loading on that payout is about $807.69. Her gross unused annual leave payout would be approximately $5,423.07 before PAYG withholding.

If Maya had taken that leave while still employed, you would usually process the payment like ordinary wages, with super generally payable on the ordinary time earnings component.
Because Maya is resigning and receiving unused leave in her final pay, you should process it as an unused leave payment on termination and apply the ATO withholding method.
Super is generally not payable on the unused annual leave payout because it's paid on termination.
The amount Maya receives in her bank account will be the gross payout minus PAYG withholding and any lawful deductions.

This is why two employees with the same leave balance can see different take-home amounts. Salary, pay cycle, reason for termination, leave loading entitlement and overall income can all affect withholding and year-end tax outcomes.

Can Employees Cash Out Annual Leave While Still Employed?

An employee may be able to cash out annual leave while still employed, but only if strict conditions are met. Cashing out isn't a general right that either side can force, so you should treat it as a careful, documented process rather than a quick payroll adjustment.

For award or enterprise agreement covered employees, the award or agreement must allow cashing out and the required process must be followed. For award and agreement-free employees, cashing out can occur by written agreement if the NES requirements are met.

Eligibility To Cash Out

The employee must retain at least four weeks of accrued annual leave after the cash-out.
There must be a separate written agreement for each cash-out occasion.
The employee must be paid at least the full amount they would have received if they had taken the leave.
If leave loading would have applied when the leave was taken, it must be included in the cash-out amount so the employee receives at least what they would have received for taking the leave.
Cashing out must be voluntary. You can't pressure an employee to cash out annual leave.
Many Modern Awards limit cashing out to a maximum of two weeks in any 12-month period, but you should always check the specific award or agreement.

For more detail on limits and process, see our overview on Cashing Out Annual Leave.

Tax And Super When Leave Is Cashed Out

If annual leave is cashed out while employment continues, it's generally taxed like ordinary earnings in that pay cycle. Super is also generally payable because the payment is connected with the employee's ordinary hours, although annual leave loading can have more nuanced super treatment depending on what it represents. An accountant or payroll specialist can confirm the correct treatment for your payroll setup.

Cash-Out Agreement Outline

A cash-out agreement should be tailored to the employee, the applicable award or agreement, and your payroll process. A practical outline usually includes:

Employee And Employer Details: identify the parties and the employee's role.
Leave To Be Cashed Out: state the number of hours or days being cashed out and the pay period it relates to.
Payment Calculation: record the base rate, any leave loading and the gross amount payable.
Remaining Leave Balance: confirm the employee will retain at least four weeks of annual leave after the cash-out.
Voluntary Agreement: confirm the request and agreement are voluntary and no pressure has been applied.
Signatures And Date: ensure both the employee and employer sign before payment is processed.

If an employee is leaving soon, it may also be useful to read about Annual Leave On Resignation and how leave is handled in final pay.

Employer Obligations And A Practical Payroll Checklist

Employers carry clear legal responsibilities around annual leave accruals, approvals, cash-outs and payouts. Good records matter because annual leave disputes often come down to whether the balance, rate and timing can be clearly shown.

Core Compliance Obligations

Apply the NES, relevant Modern Award, enterprise agreement and employment contract correctly.
Accrue annual leave based on the employee's ordinary hours of work.
Pay annual leave at the correct base rate, plus leave loading where required.
Pay unused annual leave on termination, including applicable leave loading.
Use the correct PAYG withholding treatment for leave taken, leave cashed out and unused leave paid on termination.
Issue payslips within one working day of payment and keep employee records for seven years.

Step-By-Step Checklist For Annual Leave Payouts

Confirm The Employment Status: check whether the employee is full-time, part-time, casual, award covered or agreement covered.
Check The Leave Balance: reconcile payroll records against approved leave and any prior cash-outs.
Identify The Payment Type: separate leave taken, cash-out during employment and unused leave paid on termination.
Check Leave Loading: review the award, enterprise agreement and contract before calculating the gross amount.
Apply Payroll Rules: use the correct PAYG withholding category and super setting for the payment type.
Prepare Clear Records: itemise the payment on the payslip and keep any cash-out agreement or termination documentation.
Pay On Time: follow any award, agreement or contract deadline for final pay.

Useful Policies And Agreements

Employment Contract: sets out leave entitlements, leave loading, approval processes and notice requirements for requesting leave.
Workplace Policy: explains how employees book annual leave, how peak periods and shutdowns are handled, and how cash-out requests are assessed.
Cash-Out Agreement: records each cash-out occasion and confirms the employee will retain the required leave balance.
Payslip And Payroll Records: show leave taken, balances, loading, tax withheld and final pay items.

If you need to finalise departures or redundancies, it can also help to prepare the right termination documentation and check entitlements carefully. Our Employee Termination Documents Suite is designed to support a smooth and compliant process from notification through final pay.

What If There Is A Dispute?

Disputes can arise where leave balances are unclear, leave loading has been missed, or final pay is delayed. Withholding an employee's wages or entitlements can breach workplace laws and expose your business to penalties. If you're unsure how to proceed, take a look at our guidance on Withholding Pay From Employees and get advice before taking action.

Key Takeaways

Annual leave is taxable whether it's taken, cashed out while employed, or paid out when employment ends, so you need to apply the correct PAYG withholding treatment.
Unused annual leave paid on resignation or termination is generally treated as an unused leave payment, not an Employment Termination Payment.
The payout must include leave loading if the employee would have received it when taking annual leave during employment.
If leave is cashed out, the employee must receive at least what they would have received for taking the leave, including loading where it would have applied.
Super is generally payable on paid annual leave taken during employment, but generally not on unused annual leave paid out on termination.
You should keep accurate records, use written cash-out agreements, issue compliant payslips and check ATO withholding rules before processing final pay.

If you'd like help with employment contracts, workplace policies, annual leave cash-out agreements or final pay processes, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.

Annual Leave Payments Explained For Australian Employers