Vacation pay is subject to CPP, EI and income tax: 2026 rules

Vacation taken is regular pay; vacation paid out uses the bonus method

Vacation pay is salary or wages, and section 5 of the Income Tax Act taxes employment income in the year it's received laws-lois.justice.gc.ca. The CRA's special payments chart marks vacation pay, public holiday pay and lump sum vacation payments as subject to CPP, EI and income tax canada.ca. What changes is the method, and that turns on whether the employee actually takes the time off.

The CRA's vacation pay page sets out the taken and not taken cases, and puts vacation pay paid continuously through the year at the labour standards rate in the not taken group canada.ca. Contributions you make to a trust for vacation credits are income to the employee when you make them, with CPP, EI and tax deducted as if you'd paid the employee directly canada.ca.

On the T4, vacation pay goes in box 14 with the rest of employment income, and in box 24 (EI insurable earnings) and box 26 (CPP or QPP pensionable earnings), for the year it's received canada.ca. The T4 box 14 page shows how those three boxes reconcile.

A $2,080 payout in 2026 carries $123.76 of CPP and $33.90 of EI

Your client's employee earns $52,000 a year, paid biweekly ($2,000 a pay), and is owed 4% vacation pay of $2,080 that she didn't take. You pay it on its own cheque in October 2026, outside Quebec, before she reaches either annual maximum.

The bonus method for CPP ignores the basic exemption when the payment is separate from regular pay: you multiply the amount by 5.95%. The T4001 shows the same arithmetic on a $450 retroactive increase canada.ca. EI is calculated as on regular pay at 1.63%, and the employer pays 1.4 times the employee premium canada.ca.

The last row is the common payroll error. Taking the $134.61 biweekly share of the $3,500 exemption off a separate vacation cheque gives $115.75, so each side underpays $8.01. The regular pay periods already used up the exemption. If you add the $2,080 to a regular $2,000 pay instead, CPP on the combined pay minus CPP on the $2,000 alone is the same $123.76.

All $2,080 goes in box 14, box 24 and box 26 of her 2026 T4.

How much income tax comes off a vacation payout?

For vacation pay that wasn't taken, you withhold income tax with the method the T4001 gives for bonuses, retroactive pay increases and irregular amounts canada.ca. Start with the employee's total remuneration for the year, less amounts like RPP contributions, union dues and RRSP contributions you withhold.

In the example, total remuneration is well over $5,000. So $2,080 divided by 26 pays is $80, you look up tax on $2,080 against tax on $2,000 for a biweekly period in her province, and multiply the difference by 26. A student who earns $4,000 in total, vacation pay included, has 15% withheld from a $160 payout: $24.

Withholding is only an estimate. The vacation pay is taxed at her marginal rate on the T1, like any other employment income.

A termination payout is not a retiring allowance

A payout of unused vacation at termination or retirement is not a retiring allowance. The CRA's retiring allowance page lists payment for accumulated vacation leave not taken before retirement among the amounts excluded from the definition canada.ca. So it can't go in box 66 or 67, it can't be rolled into an RRSP as part of the allowance, and it keeps its CPP, EI and tax deductions on the bonus method.

On the ROE, vacation pay payable because of layoff or termination goes in Block 17A as "paid because no longer working", and you add it to the insurable earnings in Blocks 15B and 15C canada.ca. Vacation pay that was included with each pay stays out of Block 17A. The ROE deadline page covers when the ROE is due.

Insurable hours follow the leave, not the money. An employee who receives vacation pay without taking any leave generates no insurable hours, while vacation actually taken counts hour for hour canada.ca.

For the employee's EI claim, vacation pay paid because of a separation is earnings and is allocated from the week of the layoff or separation under EI Regulations 36(9) and 36(10), whatever the year it was earned in. The exception is vacation pay held in a real trust fund, separate from the employer's money, which isn't allocated canada.ca.

Vacation pay counts toward the 2026 CPP and EI maximums

Vacation pay counts toward the yearly maximums like any other pay. Once an employee has paid $4,230.45 of CPP on earnings up to the $74,600 YMPE canada.ca, or $1,123.07 of EI on $68,900 of insurable earnings canada.ca, you stop deducting for the rest of 2026. The CPP max and EI max pages have the full 2026 figures.

A maxed out CPP employee can still owe CPP2. Vacation pay that lands between $74,600 and $85,000 of pensionable earnings attracts the 4% second additional contribution, matched by the employer.

Vacation pay earned in 2026 but paid in January 2027 is reported in the year it's received canada.ca, so it goes on the 2027 T4 and uses 2027 rates and maximums.

For an employee working in Quebec, you deduct QPP instead of CPP, EI at the Quebec rate of 1.30% canada.ca, and QPIP premiums, and you report the vacation pay in box 56 (PPIP insurable earnings) as well canada.ca.