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1. Am I entitled to pay any part of money back to them, since I never signed any agreement with them regarding Retention Bonus.
If they paid you in error, then you will be required to pay back any money that should not have been paid to you. If the money they paid you in error was the same amount that they later did not pay you that you were owed, then you should not owe anything else.

Quote Quoting srj
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2. Why are they asking me to pay the TAX money, and why I should claim it from IRS and pay them, Can't they do the same (Tell IRS, the money was deposited in error).
They are asking you to pay it because they effectively paid it to you. If the total was $2000, and you recieved $1500 of that, and they withheld $500 for taxes, then they are still out $2000 overall.

Quote Quoting srj
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3. What legal actions can my previous employer take, and what are my options.
They can sue, if they do sue you can provide evidence you do not owe money.

For the sake of making everything clear. I am going to try to walk through this to make sure I understand what happened.

Prior to the retention bonus you were paid normally
You received in error the retention bonus equal to 2 weeks pay
They continued to pay you properly until you left
When you left they held your final paycheck also equal to two weeks pay, as repayment for the bonus.
Now they demand you repay the withholding from that paycheck.

As llworking stated who owes who what at this point depends on your W-2

If your W-2 includes all of your regular pay and withholding plus the pay and withholding from the retention bonus, plus the pay and withholding from your last 2 weeks, then the company needs to issue a new W-2 and figure it out on their end.

If your W-2 includes all of your regular pay and withholding plus the pay and withholding from the retention bonus, but does not include the pay or the with holding from the last 2 weeks then the situation should be settled, and essentially you were just paid early for the last 2 weeks. It was not handled properly, but the money all works out.

If your W-2 includes all of your regular pay and withholding plus the pay and withholding from the retention bonus, and includes the withholding, but not the pay from the last 2 weeks, then they are correct, that you still owe the equivalent of the tax withholding. If they will accept just the Federal and State income tax, then you can send them the money they are asking for, as it should have been reflected that you overpaid, and you would have received it in your refund. Otherwise they need to handle it on their end, and issue a new W-2, however this will lead to you amending your return, and likely owing some of your refund back to the government.