[berettafan]

If you want to look at liability you might consider it was a shared oversight. The CPA, owner and even the owner's financial advisor might all share some guilt here.

I wouldn't throw away a relationship that has lasted 'years' over this. Nor would I seek any sort of reimbursement.

He does get the money either way (less tax as you correctly pointed out) although C or S corp impacts the tax treatment of the distribution.

Lastly consider that while he is out the earnings (or loss) potential of the additional tax dollars paid on the income not contributed to a 401k the math must include any additional FICA he'd have paid on the additional salary/deferral. You might also consider the impact of taking the add'l cash he now has (401k deferral less tax impact of same) and paying down debt he may have that costs more than his invested money earns.

Point being it's possibly arguable that the guy suffered a loss as big as you might initially think...or even at all if you allow for market instability assuming the 401k funds would be invested into public markets.

Full disclosure I am a CPA.