Excess refunds of excess deferrals

[Guest Iwonder]

How is the basis handled when the excess deferrals are miscalculated and participants received excessive refunds (are, in essence, overpaid) and must refund the overpayment of refunds back to the Plan?

To treat this as an after-tax contribution would mischaracterize the situation, but for participants to repay the amounts back into the plan would mean that they would pay taxes on these amounts twice, wouldn't it?

How are these amounts generally segregated out by a Trust?

[Guest mjb]

Under the claim of right theory if the employee repays the excess in the same yr then the plan admin will subtract the repayment from the excess paid and return the excesss to the participants account as pre tax contributions. Only the amount of the excess actually retained by the participant will be reported as taxable income. The reason the repayment is not taxed is that the employee had no legal right to the money which was returned to its rightful owner in the same taxable yr in which it was paid. This situation is no different from the bank customer whose account is mistakenly credited with a deposit made by another customer. The next day his account is debited by the bank when the mistake is discovered. The customer does not report the mistaken deposit as taxable income since he had no claim of right to the mistaken deposit.

[Guest Iwonder]

Under the claim of right theory if the employee repays the excess in the same yr then the plan admin will subtract the repayment from the excess paid and return the excesss to the participants account as pre tax contributions. Only the amount of the excess actually retained by the participant will be reported as taxable income. The reason the repayment is not taxed is that the employee had no legal right to the money which was returned to its rightful owner in the same taxable yr in which it was paid. This situation is no different from the bank customer whose account is mistakenly credited with a deposit made by another customer. The next day his account is debited by the bank when the mistake is discovered. The customer does not report the mistaken deposit as taxable income since he had no claim of right to the mistaken deposit.

[Guest Iwonder]

Under the claim of right theory if the employee repays the excess in the same yr then the plan admin will subtract the repayment from the excess paid and return the excesss to the participants account as pre tax contributions. Only the amount of the excess actually retained by the participant will be reported as taxable income. The reason the repayment is not taxed is that the employee had no legal right to the money which was returned to its rightful owner in the same taxable yr in which it was paid. This situation is no different from the bank customer whose account is mistakenly credited with a deposit made by another customer. The next day his account is debited by the bank when the mistake is discovered. The customer does not report the mistaken deposit as taxable income since he had no claim of right to the mistaken deposit.

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What would be a recommended procedure were the excess refund discovered in a year other than the same year? This overpayment would, ideally, be returned to the plan, but the participants have already paid taxes on the amount. Then, the money would be returned "after-tax".... but, would this be considered an "after-tax contribution" for the subsequent year?

Also, how is the money tracked?

Any suggestions

[Guest mjb]

the employee can deduct the refund as a miscellaneous itemized deduction subject to the 2% floor in the year it paid. Don't know how it would be tracked in plan.