can the employer use mistake of fact to withdrawal an unallocated contribution they made wrongfully thinking the plan would be top heavy?

Very doubtful. The mistake of fact rules are fairly narrow if I remeber correctly and do not appear to apply in this case.

I think you are going to be stuck with allocating a descretionary contribution under the terms of the plan.

You might try this thread for some additional suggestions.

http://benefitslink.com/boards/lofiversion...php/t14199.html

next question - what are the consequences if the employer takes the money back and it was not due to mistake of fact?

20% or 50% reversion tax under IRC 4980, and the plan yet being liable to the participants for benefits based on the reversion amount.

What about disqualification and ERISA penalties?