402(g) Excess When Deferrals Not Deposited

Hi all,

On reviewing a Plan Sponsor's payroll records/W-2s, I've identified that the owner's W-2 reflects total deferrals of $24.5k for 2025 (not catch-up eligible). Normally a 402(g) Excess distributions would be relatively straightforward, but in this case, the 'excess deferrals' weren't actually deposited in the Plan trust (to the tune of $5k, $19.5k actually deposited), which is why our system didn't flag the 402(g) Excess (as it would have on receipt). Let's say this was due to a missed off-cycle processed by the Plan Sponsor just for the owner to contribute these amounts.

Another complicating factor, is their payroll report indicates that they added back a positive after-tax deduction of $1k, labeled appearing to be in order to correct this, so the funds appear to have not actually been withheld from his paycheck, but the W-2 does reflect them as withheld.

In order to correct this, is the only acceptable method to fund the late deposit of the $5k EE deferrals then distribute them with accompanying 1099-R from the Plan Trust?

Is there any other permissible solutions that don't include funding the excess amount, such as correcting the W-2 or issuing a 1099-R (no accompanying payment) reporting the $1k excess as taxable for a pre-4/15 402(g) correction?

If the funds weren't actually withheld and the $1k excess was, in fact, paid to the individual, does any correction (other than possibly the W-2) need to take place at all?

The employer and the plan’s administrator (whether these are the same person or distinct persons) might—after considering each’s lawyer’s, certified public accountant’s, or enrolled agent’s advice—consider whether to check the facts of what happened, including what deferral election the participant properly made, made invalidly, or made not at all.

Might the “off-cycle” not have been compensation from which an actual and proper deferral could be made?

Do the documents governing the plan grant the administrator authority to refuse a participant contribution because it would exceed a deferral limit?

Does a salary-reduction agreement or other form state that the employer will or may interpret a deferral election as limited to the lesser of the amount specified or the largest amount that would not exceed an applicable deferral limit?

Even if not expressly stated in any writing, might the plan administrator’s interpretation of that kind be a prudent interpretation of the documents governing the plan?

To the extent a participant contribution was not sent to the plan’s trust and was not a proper deferral, might the employer make its Form W-2 wage report follow that truth?

Is there time to find the law, plan provisions, and facts with time for the employer to do its wage report by next Monday?

This is not advice to anyone.

I really am not following everything in the facts in OP (I don't understand the facts in the second paragraph of the OP so won't be addressing anything related to that paragraph) but your client could have an operational failure that would need to be corrected under IRS EPCRS (need to determine if the plan documents require the amounts to be contributed by a certain time period) and your client definitely has a failure to timely deposit the contributions that would need to be corrected under DOL VFCP.  Under EPCRS, normally corrections are limited to contributions that could be made without exceeding an IRS.  Thus, under that reading, if an operational failure occurred, the correction appears to be limited to $4,000.  However, for VFCO failures, I don't recall any language in the VFCP that would limit the contribution.  In fact, the DOL's general view is once the amounts are withheld from the participant's pay, the withheld amounts are plan assets.    So, conservatively speaking, it appears the correction under VFCP would include the full $5,000.  If you have both an operational failure and an failure to timely deposit, a conservative approach would correct by contributing the full $5,000 as there is also a method by which to correct the excess deferral (and if done prior to April 15, there should be no downside to correct the excess deferral).

Also, normally, under the corrections principles for both, employers do not adjust the Forms W-2 for the corrections.  So the employee's W-2 would not be adjusted.  A 1099-R would be issued for the return of the excess deferral in the following year by April 15 with the amount of the excess deferral and earning contained in Box 2 and using a Code P.

Again, I don't fully understand what happened with the $1,000 but if not put in plan and paid to employee, normally that would go on the Form W-2 so a W-2C might be needed (employees typically do not receive a 1099 and it wasnt from plan so no 1099R)'

Flying by the seat of my pants here so absolutely not advising you... just spitballing