Deferrals from severance pay - how to return them?

[AlbanyConsultant]

A client 'fessed up and said that they had given a participant $2,000 in severance pay (that isn't for the payment of unused sick or vacaton time - they actually used the word severance).  The participant deferred exacty 10% of gross pay, so while it's still being checked, I'm pretty sure that they took deferrals from the severance, too.  Let's say this is the case.

Obviously, that is not allowed - if it's not eligible for plan compensation, you can't defer from it.  So what is the authority to return those deferrals?  It's not a 402(g) failure, and 415 wasn't violated.  It's not an excess deferral.  What is it?  Mainly, I want to know for (a) timing, (b) taxation, (c) earnings calcluations, and (d) to look smart when I tell the plan sponsor. 

Thanks.

[K2retire]

Might this be considered a "mistake of fact"?

It could also be a 415 violation because it was taken from compensation that isn't included.

[RatherBeGolfing]

The ERISA Outline book says to reverse payroll if not yet deposited to the plan.  

If already deposited to the plan:

Quote

(1) distributed to the individual in accordance with the “excess allocation” rules under the IRS EPCRS Procedure, 

or (2) credited against future employer contributions and the employer makes the individual “whole” by issuing a check to the individual for the mistaken deferral amount.