Employer deposited a few weeks ago a ps contribution for 2008 to their 401k plan which has not yet been allocated to participants. Employer now wants to take it back. Can they do that?

No.

I don't know how to create a link to an earlier post, but I did a thread on this topic on January 30, 2008. The topic was "Deposit of Employer Contribution". Sorry I can't provide the link, but that is the thread you want.

Can't take it back, but could choose to allocate it to 2009 instead.

Here's the link to Below Ground's reference:

http://benefitslink.com/boards/index.php?s...c=37751&hl=

K2, would your answer change if they have already filed their 2008 return and deducted the contribution? I don't know that to be the case, but given the time of year, it seems likely.

When the taxes were completed last week, they did not deduct the contribution for 2008 since they knew they wanted to take it back. Options then are to use it for 2009, or pull it out. Client preference is to pull it out and decide on 2009 later. Think that can still be done? Would another option be to restate part of the deposit as 2009 401k for the owners and the remaining leave as nonelective?

Yes my first answer would be different it it had been deducted.

You're allowed to take the money out of the plan in only very limited circumstances. Changing your mind is not one of them. I believe their only option is to leave it there to use for 2009, unless there's additional information that we don't have yet.

Sounds like it was not designated as a 2008 contribution, so it would be a 2009 contribution.

I think the timing rules in 1.401(k)-1(a)(3)(iii) prevent reclassifying any of the deposit as salary deferrals.

I agree with K2. Taking the money back is not an option. As I understanding, exceeding the deductible limit is the only reason that is agreed to be allow a "refund".

Okay, no issue exceeding deductability limit. Sounds to me the money is staying in the plan as 2009 contributions, that's that.
I looked at the timing rules and see that it says 'Contribution may not precede election'. My understanding of this is that a plan needs to have established the 401k feature before declaring contributions as such. Since this plan already has 401k, I still wonder if part of this deposit can be restated as such since the 2 owners have already made election to make 401k.

How do the owners show that the funds were deducted from their pay? That is a requirement for a 401(k) contribution.

That's not exactly what the timing rules say. The contribution must be made after the employee makes an election to defer. The contribution must be deposited after the earlier of 1) when the services are performed or 2) when the pay is currently available. That means no retroactive elections and no pre-funding of deferrals.

Are the owners receiving W-2 compensation or do they have earned income?

You are both correct that payroll/company taxes are a weak point of mine.
They have earned income and they have already deferred $10,000 each this year.

Well, I explained to them that they could not take back that contribution but that their only option is to designate as a 2009 nonelective. They said that is not acceptable and are telling the investment company they need it back as soon as possible.

I wonder if the investment company pays it back to the company if the IRS, EEs and/or the DoL will have their own ways of saying that's not acceptable.

Did you explain to them that this prohibited transaction will need to be reported on their 5500?

If they are thinking they won't report it on their 5500, they should take a look at this article.

http://www.plansponsor.com/pi_type10/?RECORD_ID=41013

And don't forget the paid preparer penalties if they tell you to prepare the form 5500 without reporting the PT.

Thanks for posting that article!