Correction of a Rollover Reversal

[BTG]

First, my apologies for interrupting the NCAA tournament.

A participant in a cash balance plan requested a lump sum rollover to an IRA. The plan custodian cut the check and it was accepted by her IRA provider. Shortly after the check was cashed, however, the participant informed her IRA provider that she had changed her mind and directed the provider to reverse the rollover. The IRA provider wrote a check back to the plan, which, unfortunately, the custodian accepted without mentioning any of this to the employer. The custodian then issued a Form 1099-R, showing that the participant had rolled over her entire account balance in 2008 (notwithstanding the fact that the plan again has possession of the funds).

Nothing in the plan document would have allowed the rollover back into the plan, because the plan does not have rollover accounts.

My thoughts/questions:

(1) One option would be to treat this as a cancelled rollover election, and to issue a corrected 1099-R showing that no amounts had been rolled over in 2008. This seems like an extremely aggressive (if not disingenuous) position, since the check was actually cashed and the amount actually went into the IRA. Does anyone disagree?

(2) A better option (in my mind), would be to acknowledge that a rollover did occur in 2008 and that the plan improperly accepted a return of the funds from the former participant. Presumably, this would be an operational error that needs to be corrected under EPCRS and the amount must somehow get back into an IRA for the former participant. But I'm not clear on how the corrective distribution should be structured... Can this amount properly be characterized as an eligible rollover distribution? Does the amount need to be credited with interest at the plan's stated rate from the date of improper acceptance to the date of distribution? How should these transactions be reflected on the Form 1099-R?

Any thoughts would be greatly appreciated.