Thank you for the additional information, Tom
Neither state nor federal law requires employers to provide PTO time or to permit employees to cash out accrued time. Therefore, this issue is not highly regulated at all typically.
While an employer must not discriminate against employees based on a protected status with regard to any term of employment, including this, they are normally free otherwise to set and enforce their own policies with regard to how and when PTO time may be cashed out.
Having said that, they must withhold taxes from such pay, similar to withholding for normal wages, according to state and federal laws and regulations, including IRS regulations. But the employer would not be restricted by IRS regulations from providing this benefit to employees. The IRS regulations would merely dictate how much in federal taxes must be withheld from such pay.
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