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What does the auditor propose doing? Is the error within the auditor's materiality standard? If you are going to have to restate prior financials, I would push back hard. If that's not the remedy proposed by the auditors -- maybe get counsel to look at the issue and opine that everything is pretty much OK. Note that a new firm of auditors will have to focus on this issue so make sure you have your resolution tidily addressed in your files.

How one reasons a finding about whether a person remains, or is no longer, a participant might turn on the purpose for which a plan’s administrator makes such a finding. Just to pick two of the many purposes that might call for a finding: If the purpose is a count of participants for a Form 5500 annual report, the Instructions state: “An individual is not a participant covered under an employee welfare plan on the earliest date on which the individual (a) is ineligible to receive any benefit under the plan even if the contingency for which [the] benefit is provided should occur, and (b) is not designated by the plan as a participant.” If the purpose is discerning whether someone is a participant with information rights under ERISA § 104(b)(4), one would use the statute’s definition of participant. ERISA § 3(7) defines a “participant” to include someone “who is or may become eligible to receive a benefit[.]” The U.S. Supreme Court held this includes an employee with “a colorable claim that” she will “in the future” fulfill eligibility requirements. Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 10 Empl. Benefits Cas. (BL) 1873, 1881 (Feb. 21, 1989). Justice Scalia’s concurring opinion would include “those who (by reason of current or former employment) have some potential to receive the vesting of benefits in the future[.]”

It depends as others have said. The TPA for whom I work, mandates the plan sponsor (i.e. the employer) approve online, or sign off on all distributions, no matter what they are. They have to make sure the hardship distribution is in line with the plan document. Not sure why it would be a big deal for them to know.

If your employer lets you go, you don't HAVE to pay back a loan. Any outstanding amount will become taxable income to you. The hardship withdrawal is also taxable income to you.

A hardship withdrawal relates to the plan and not the employer. That said, plans vary in visibility to the employer of plan activity. Employers are not legally allowed to take adverse action toward an employee because of exercise of the exercise of rights under the plan, such s taking a hardship distribution. That is an abstract legal proposition that may not be true in practice. You were informed how to interact with the plan and your account. It may be that you directly contact a service provider, such as an insurance company or an investment company (e.g. Fidelity, Vanguard, T.Rowe Price) or another type of administrative services plan, or someone at the employer, typically in HR. If you are clueless, then ask some HR representative how you can connect with your account. You may be referred to information materials that explain it to you, or you may be given a direct answer, such as a name and phone number or a website. You will be asked about the reason for the withdrawal and the amount needed to assure compliance with the hardship withdrawal rules. As mentioned above, your employer may be privy to the information, or not. I am offering no comment on your thinking about loan vs. hardship. You should rethink, preferably with the aid of a plan representative, if that is available. Generally, hardship withdrawal is a last resort (at least in the view of professionals n the industry) and you may not understand the effects of a loan, even facing the prospect of losing your job, and defaulting on the loan. It is probably no worse than the consequences of a hardship distribution. Some plans do not allow hardship withdrawals if a loan is available to cover the need.

Yes, 81-105 and the 1983 proposed regs are still in effect. Shout out to Derrin Watson's "Who's the Employer" which succinctly answers this and (I have not counted but probably) thousands of other questions.

Relius (formerly Corbel) has a very good Manual of issues (not a checklist) if you utilize their plan document for any 457 plans.