Leased employees allowed in plan

I have a plan where the plan sponsor mistakenly submitted census' for the plan that included some leased employees despite being excluded plan document. That caused safe harbor non-elective and profit sharing contributions to be made on their behalf for several years.  Now that the plan sponsor has realized the mistake they want to move these employees out of the plan.  I assume that we cannot forfeit the balances like the plan sponsor wants.  Any idea on the correct way to handle this?

You can forfeit them, they weren't supposed to have those allocations in the first place.  Put the plan in the position it would have been if it had been done correctly, and so those ineligible folks still end up with $0.

It's important to make sure that they really are Leased Employees as defined in 414(n) - not every person who works for one company but gets a paycheck from another is a true 414(n) leased employee. Who's the Employer has a good chapter on the issues that need to be considered.

If they really are 414(n) leased employees, then the correction (that doesn't involve retroactively letting them into the plan) would be to move the money out of their accounts and reallocate under the formula in the plan document for the year(s) in question. You would have to go back and re-do the testing for those years too; 414(n) leased employees are non-excludable so now you have to watch your coverage test.

And as always, check the plan document, almost all plans have provisions for mistakenly included/excluded employees.