CPS has been unable to agree with the union on a plan to distribute the money and the union wants an investigation.
The $34 million was granted in 2010 as part of an incentive program. Teachers whose students improved academically or who chose to teach underserved subjects in tougher schools would be paid up to $15,000 more
"It is sad we have to give back $34 million to the feds when I know teachers could actually use the money," said CPS CEO Jean-Claude Brizard.
Karen Lewis of the teachers union said "merit pay" does not unite its members.
The union said it never signed on to the project and wants a federal investigation into how CPS got the money.
School administrators said the union simply refuses to cooperate in modernizing the system.