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Yes, an employer must correct a W2 if it is wrong. If the pension loan was taxable income, yes you should withhold taxes for it.
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I cannot speak as to your tax question, but all employers have a legal duty to correct incorrect W-2 forms. Contact the IRS and New York State Department of Taxation immediately if your employer refuses to do so.
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I am assuming that you are saying that you have taxable income for 2012 in the amount of $25,000 due to the fact that you defaulted on a loan from your pension plan with a $25,000 balance outstanding. Pension loans that are repaid in a timely manner do not generate taxable income, however, hardship distributions, which are not repayable to the plan, do generate federal and state income tax and generally also a 10% federal early distribution penalty tax. If defaulting on a loan from a tax-qualified pension plan and having to recognize $25,000 in additional income for 2012 is the issue and this is what is generating the extra $10,000 in tax liability (federal income tax, state income tax, plus applicable penalty tax), then you need to make payment to the IRS and the relevant state tax authorities in a timely manner or else face additional penalties and interest charges.
Note, however, that your Form W-2 supplied by your employer may NOT be incorrect simply because it does not rec=flect the $25,000 defaulted loan amount as additional taxable income on Box 1 (wages) or on any other box of Form W-2. employers and their pension plans report plan distributions, including defaulted loan amounts, which are deemed "constructive distributions" on Form 1099-R, not on Form W-2. You may wish to ask your employer's payroll department or accountant if they pan to send you a Form 1099-R reflecting the additional income from the defaulted pensin loan if this is indeed what occurred--I'm kind of surmizing from your question that this is the case.