What portion of a corrective distribution is included in employees' gross income when it is distributed?

The entire taxable portion of a corrective distribution is included in an employee's gross income when it is distributed. A corrective distribution typically arises when there is an excess contribution or when the 401(k) plan fails to meet specific compliance requirements. In these scenarios, not only does the excess contribution need to be returned to the employee, but the associated earnings must also be included in the distribution.

Because the excess contributions and the earnings resulting from those contributions are considered taxable income in the year the distribution occurs, both elements are subject to taxation. This means the employee must report the total of the corrective distribution, which encompasses any previously non-taxed principal amounts as well as the earnings that accrued, leading to a comprehensive impact on their taxable income.