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I think it assumes more than $1,000 as an account balance but with a $1,000 request. Which I would agree with.

Yes. It is so small that a correction is unnecessary. What is frivolous about that argument?

There are only very limited circumstances in which deferrals can be withdrawn - attainment of age 59-1/2, termination of employment, financial hardship, or termination of the plan. If none of those have occurred then you have an operational failure. If the failure is significant (sound like it is to me) then you would have to correct under VCP since it is more than 2 years after the failure. The correction will likely be to have the employees return the overpayments to the plan. For payments that have already been taxed, return of the payment will create after-tax basis in the plan.