Impermissible hardship distribution

[Belgarath]

I've tried several searches, but was unable to locate this specific circumstance, so here goes.

Participant requests a hardship withdrawal. The Trustee signs the withdrawal form and sends it to the funding institution/broker, who processes the withdrawal, withholds 20%, and sends the balance on.

This raises all kinds of problems. First, the participant was only eligible for a hardship withdrawal of $1,200, but the withdrawal was $2,500. So there's an impermissible distribution of $1,300. Then, 20% withholding was done on the whole amount, which is also wrong. And while we don't know, the reporting by the funding institution is almost certainly incorrect.

The fix under Revenue Procedure 2006-27 is fine. My question is: since this participant has (apparently) no money whatsoever, what happens when the participant refuses to repay the plan? The standard language in the Rev. Proc. would require the sponsor to repay whatever the participant does not. However, this contemplates a different situation, and I don't believe it is appropriate to give the participant a windfall.

Whether the employer can require withholding this from the participant's pay is probably a matter of state law. Just wondered if anyone had encountered a similar situation, and if so, how did you handle? I've seen no IRS guidance on this.

Thanks!

[QDROphile]

Why is this windfall any different from any other mistaken distribution windfall?

[Belgarath]

Because I believe the standard correction language was designed for a situation with a terminated participant where there are group funds, and without an employer replacement of funds, other participants suffer a reduction in their benefit. Somehow, this seems like a whole different level than replacing the money where no one else is harmed and ONLY the participant receives the replaced money, which he already received once in the first place. I can justify the first situation better than I can the latter.

Thoughts?