2005 money returned - employee not eligible yet

[Guest akv]

I apologize if this topic has been addressed before. I was directed to here from the APA Listserv.

We had an employee that had around $350 for 401k withheld in 2005. I just received a letter from our 401k administrator (along with a check for the amount of his deferrals) that states that he was not eligible to defer until January 2006. The letter just says that we should tax the employee on the money.

What form do I fill out to ensure he gets taxed on it? There seems to be several theories from (1) simply adjust his 2006 W-2 (because that is when he is receiving the money back), (2) give him a W-2c for 2005 or (3) give him a 1099 R for 2006.

Any assistance you can give me is greatly appreciated.

Angie

[Jim Chad]

I was surprised no one had answered this question until I thought about it. There is no answer to your question in the regs because your 401(k) administrator is not handling this right. This error is not a distributable event. The money should not have been given to the employee from the Plan. It should have been forfeited and he should have been made whole outside the plan.

This isn't as bad for the employer as it looks like at first. There are many ways he might use the forfeitures that will decrease his expenses in other areas.