Ineligible distribution w/out 1099-R

Partner who is Active and not eligible to take an inservice went ahead and rolled over his account to an IRA without informing Plan Administrator. No 1099-R ever issued. (Reason was to get more control over his assets.)

Looks like under Self Correction it needs to be returned to the plan with earnings.

Questions:

Does a 1099-R need to be issued at all for either transaction? The first one was in prior year.

Can a 'Rollover IRA' that holds only this account be re-stated as a Plan account?

I guess this is an operational failure because the distribution did involve a failure to follow the written terms of the plan document (i.e., distribution made when not eligible for the distribution).  As you state, the corrective action is to return the amount of the distribution plus earnings to the plan.  The employer is required to notify the participant that the distribution is not eligible for rollover reporting on a 1099R (so Code 1 or perhaps 7) and presumably requests the return of the amount to the plan.  A late 1099R likely should be issued (there was a plan distribution) but there may be penalties for issuing it late. Note, the employee is not required to return the amount (at least under EPCRS).  If they don't, the employer has to make a contribution to the plan in the amount of the distribution plus earnings.  If this is an issue, the employer may wish to file under VCP to ensure the employee does not get a double dip (VCP would be used to put forth a proposal of what will be used with the employer contribution... for example, to be allocated to other participants or what).  At least state that the unreimbursed distribution was an "advance payment" of their benefit.

Based on your characterization of the facts, it appears that the participant accessed funds without Plan authorization so the transaction appears to involve a fiduciary breach and possible prohibited transaction.  This person appears to be a fiduciary, even if not named one, because they have the functional ability to make discretionary distributions under the plan.  As a fiduciary, the Plan may be able to sue them as fiduciaries are personally liable to make good to the plan any losses resulting from their breaches. If the DOL gets involved, there could even be criminal prosecution (or state law violations of embezzlement laws).  

If the participant improperly accessed funds there likely is a prohibited transaction under Section 4975, specifically an unauthorized transfer of plan assets for the participant’s benefit (i.e., self-dealing).  This could be treated as a deemed distribution plus a prohibited transaction with an excise tax (15% initially and 100% if not corrected within each taxable period not corrected).  Also, for the IRA, loss of IRA status.

There is also possible plan asset control failure by the Plan fiduciaries.  The Plan sponsor and the Plan administrator should review the distribution controls and determine how the participant could do this.  Recordkeeper error?  Admin approval failure?  Participant circumvention? All of the above?  Then, document the facts, corrections and methodology of correct and finally add some internal control improvements to ensure this cannot occur again.  

This violation does not appear to fall under VFCP.

All of the above should be thoroughly documented in the event of an IRS and/or DOL audit(s).

Just running through thoughts as they come to me....