Distribution Made in Error & 5330

[CLE401kGuy]

August 2010 employer incorrectly pays out a $10k account balance as a lump sum - $8k to participant, $2k FIT - participant was not eligible for distribution - $10k is noted on 5500 as a PT.

October 2011 participant pays back $8k that was rec'd - but the FIT is not recovered... As of July 2012, no 5330's have yet been filed - the kicker: the plan terminated 1/1/12 and the participant's balance has been paid out in full under the termination.

1) is one 5330 completed at this time for 2010 and 15% excise tax is based on lost earnings for the period 8/10-12/10? this 5330 is late...

2) is a 2nd 5330 completed for 2011 showing 2 PT's - the first for the lost earnings related to '10 reported on the late 5330 noted in item 1) above and a 2nd PT that is the lost earnings based on the full $10k from 1/11-10/11 + lost earnings on the unpaid $2k for the period 10/11-12/11? this 5330 can be extended still

3) since the plan is now paid out due to termination - how is the $2k portion of the PT that was never resolved handled?

4) the employer had paid no lost earnings to the plan - and since it is now terminated and fully paid out, there is no plan to pay lost earnings to regardless, how are the lost earnings handled?

Any thoughts would be appreciated...

[ETA Consulting LLC]

I have some general thoughts. I don't think every event where you fail to follow the terms of the plan results in a Prohibited Transaction. For instance, I can see a clear distinction of an event where (for instance) a distribution was given to a business as a gift (prohibited transaction) and an event where a participant received a distribution of his own account balance prior to the time a distribution was allowed under the written terms of the plan.

A failure to follow the plans terms is a violation, I just don't believe it's a prohibited transaction.

In any event, when the $8K was returned, the resulting taxable distribution was $2K where 100% of it was withheld and sent to the IRS. Depending on the timing, you could've netted that $2K with the next wire to the IRS and reflected no withholding for that individual participant when you balance the Form 945 at year end. Otherwise, you'd have to report the $2K as a taxable distribution.

There is some flexibility on correcting under VCP. I just think the initial treatment as a prohibited transaction wasn't the best approach. I'd try to undo this, to the extent no actions were taken, and just treat it as a failure to follow the written terms of the plan (correct in a different manner).

Good Luck!