Legal updates

September 18, 2025

On September 18, 2025, the Illinois Supreme Court ruled in favor of the City of Pekin on a case

involving the alleged improper tax withholdings under the Illinois Public Employee Disability

Act (PEDA). During the Supreme Court proceedings, Clark Baird Smith LLP was honored that

the Illinois Municipal League (IML) asked it to file an amicus curiae brief on behalf of Illinois

municipalities throughout the State.

As background, PEDA requires injured police and fire personnel to be paid on the same basis for

up to a year after a workplace injury. On one hand (the viewpoint ultimately adopted by the

Supreme Court), this implies that PEDA-eligible employees generally should continue to receive

their pre-injury compensation, which typically also includes the withholding of State and federal

taxes. On the other hand, under IRS regulations, payments “in the nature of” workers’

compensation are typically not treated as “income” for tax purposes.

To summarize the Supreme Court’s decision, we have developed the following Q & A:

What is the Supreme Court’s Primary Holding?

A public employer does not violate PEDA if it continues to withhold State and federal taxes from

an employee’s PEDA compensation on the same basis it withheld taxes from paychecks before

an injury. Any sort of error about improper tax withholdings needs to be addressed by the

employee through the IRS--not the employer or in court.

Are PEDA Earnings Taxable Under Federal Law?

Even though the Supreme Court initially seemed to reject the notion that PEDA payments are “in

the nature of” workers’ compensation” in accordance with IRS regulations, without making any

definitive ruling about taxability, the Supreme Court explained that: “[e]ven assuming, however,

that the plaintiffs are correct and that [PEDA] payments are not subject to federal income tax,

that does not mean that an injured employee is wrongfully denied amounts owed to him when the

employer withholds employment taxes. Instead, it simply means that the employee must seek a

refund from the IRS or adjust his tax withholding by submitting a new W-4 withholding form to

his employer.”

Are PEDA Earnings Taxable Under State Law?

Again, the Supreme Court held that under PEDA, employers can continue to withhold taxes,

including State income taxes. Notwithstanding, the Court did not analyze or make an express

finding as to whether PEDA compensation is subject to State income tax. Furthermore, unlike its

analysis under federal law, the Supreme Court also did not describe the process of situations in

which employees complain about alleged improper withholdings under Illinois law. However, we

note that the Illinois Income Tax Act states that no employee shall have a right of action against

an employer for improper withholdings. 35 ILCS 5/705.

Should Our Municipality Make Tax Withholdings From PEDA Pay?

We reiterate that the Supreme Court’s decision was limited to PEDA. Nevertheless, the Illinois

Supreme Court definitively held that employers are not prohibited from continuing to withhold

State and federal taxes from PEDA compensation. In that respect, we would suggest that you

consult with your labor and employment counsel and tax advisors about next steps.