A lawsuit, picked up by the ACLU, was filed after a resident said the cross challenged his civil liberties.
The town conceded the case, and crews removed the cross from the top of the tree on Monday.
"It is with regret and sadness that the Knightstown Town Council has had the cross removed from the Christmas tree on the town square and is expected to approve a resolution at the next council meeting stating they will not return the cross to the tree," the town said in announcing the settlement.
But according to CNN affiliate WISH
, residents say their fight isn't over.
"It's just ridiculous," resident Aaron Magee told WISH. "I'm very offended that the cross was taken down, and I want it put back up. We all want it put back up."
Protesters have started placing their own crosses on the tree and handing crosses out to those walking by.
ACLU-Indiana Legal Director Ken Falk disagreed with the town and protesters.
"The cross is not a Christmas symbol," Falk said. "The cross is the pre-eminent symbol of Christianity and it reminds Christians not of the secular trappings of Christmas, but of the crucifixion and the resurrection of Jesus."
Most of the response from social media has sided with the town's officials.
One Indiana resident found religion an inherent part of the town's history.
Another cheered on the townspeople for taking the matter, and their crosses, into their own hands.
But some posters agreed with Falk and the town's decision.
For now, Magee and other protesters hope to bring back what they see as the reason for the holiday season.
"If you can't have Christ in your heart, I don't know what you can have," said Magee.
Another protest is planned for 1 p.m. Sunday.