The forest-floor litter layer can retain substantial volumes of water, thus affecting evaporation and soil-moisture dynamics. However, litter layer wetting/drying dynamics are often overlooked when estimating forest water budgets. Here, we present field and laboratory experiments characterizing water cycling in the forest-floor litter layer and outline its implications for subcanopy microclimatic conditions and for estimates of transpiration and recharge. Storage capacities of spruce needle litter and beech broadleaf litter averaged 3.1 and 1.9 mm, respectively, with drainage/evaporation timescales exceeding 2 days. Litter-removal experiments showed that litter reduced soil water recharge, reduced soil evaporation rates, and insulated against ground heat fluxes that impacted snowmelt. Deadwood stored ~0.7 mm of water, increasing with more advanced states of decomposition, and retained water for >7 days. Observed daily cycles in deadwood weight revealed decreasing water storage during daytime as evaporation progressed and increasing storage at night from condensation or absorption. Water evaporating from the forest-floor litter layer modulates the subcanopy microclimate by increasing humidity, decreasing temperature, and reducing VPD. Despite the relatively small litter storage capacity (<3.1 mm in comparison to ~102 mm for typical forest soil rooting zones), the litter layer alone retained and cycled 18% of annual precipitation, or 1/3 of annual evapotranspiration. These results suggest that overlooking litter interception may lead to substantial overestimates of recharge and transpiration in many forest ecosystems.