If an individual exceeds the 402(g) deferral limit, how is an investment loss handled when the excess deferral is returned?
Rev. 04/03/03, E-mail Alert 2003-6

The full amount of the excess deferral must be reported for tax purposes — even if there has been a loss and the amount being returned is less than the actual amount of the excess. For example, assume the excess deferral was $1,200. After an investment loss of 20%, the current value of the excess is now $960, which is the amount being returned. However, the entire $1,200 must be reported on the 1099R.

To reflect the loss, the employer should provide the participant with a written statement so that he or she can report the loss on the “Other Income” line of his or her Form 1040. The loss must be reported for the year in which the excess is returned. Excess deferrals must be corrected by April 15, in order to avoid double taxation regardless of whether April 15 is a weekday or weekend.