Wrong Correction Method for Excess 401(k) Deferral in 2020

Posting for an ex-colleague.  Their company is paid bi-weekly and had 27 pay periods in 2020 instead of the normal 26.  One of their payroll people miscalculated their own 401(k) contribution, intending to contribute the maximum  $19500 over 26 pay checks, but instead overcontributed by $750 because of the extra paycheck.  But instead of having the excess paid to them out of the plan like you are supposed to, the payroll person took it upon themselves to adjust their own W-2 and adjust their own paycheck so that they could get the money back from the employer instead of taking it out of the plan.  No 1099 issued, no earnings on the excess.  It is a large company and no one is likely to notice but my colleague thinks this is a problem.  I am being careful not to express my opinion but I sure know what I think.  How big a problem is this, if it is?

Are you saying she got the $750 as income and also left the 401(k) contribution in the Plan?

If that's the case as I understand it you have theft of $750, an uncorrected 402(g) excess, and an incorrect W-2. If they reversed the $750 contribution out of her account while running a corrected payroll and W-2 due to the unexpected 27th payment, you're probably fine. But it sounds like the former was done and not the later.

From a plan perspective, was his next deferral a negative $750? Is the plan and his account square? It is unclear from your description if all the required +'s and -'s have occurred. As it was last payroll and probably the last business day of the year, I don't think earnings are an issue, no more gap period interest, right?

I think the bigger picture problem is that you have an individual, especially in a large company, who was able to manipulate his W-2, payroll and 401(k) on his own without any apparent oversight or controls. If the cash does not reconcile to account and/or payroll records - it may or may not show up on plan (CPA) audit or IRS audit - but if it does, I think the issue is much greater than a compliance limit.

Yes, the required refunds have been made so the money part is OK.  But the contribution (and earnings, if any) did not come out of the plan as a distribution to the participant with a 1099.  The $750 came back to the company and went back to the employee through the payroll system in 2021.  The accounting records look as though the extra $750 never happened unless you look deeply.  And yes, CuseFan, I agree that there is a bigger problem than just the limit.  It is also unclear how the extra $750 was contributed in the first place because normally the payroll system cuts people off when they hit the maximum for their age.

Looks to me like it was corrected by reversing a payroll error that shouldn't have happened.

If this happened say 9/15 and then was reversed with a negative deferral on the next payroll, say 9/30, would we even be having this discussion?

There has been no mention of matching contributions - so it that not an issue here?

Again, bigger issues, an individual's ability to manipulate data/systems w/o oversight/controls (at least in appearance) - which may not be your ex-colleague's place to bring up - and the payroll system's failure to properly limit, although that could have been due to the oddity of the payroll calendar and a last minute change. That is something your ex-colleague should bring up.

I know our company was originally going to keep 26 bi-weekly pay periods for 2020 but then decided early 4Q to accelerate Friday 1/1/2021 to Thursday 12/31/2020 and make 2020 a 27 pay period year because it would be paid that day - and probably easier to do that rather than pay on 12/31 effective 1/1 and include in 2021.