A severance plan (welfare plan) lost it's tax exempt status. All of the plan's assets were distributed leaving 26K remaining. What can legitimately be done with this remaining money?

Please advise.

Presumably the "tax-exempt" status you refer to was as a 501©(9) trust. As such the excess funds may only be used to provide benefits to employees, their dependents and beneficiaries. Funds may not revert to the employer, nor may they be used to provide disproportionate benefits (or inure to the benefit of private shareholders or individuals). A couple of private letter rulings have approved distribution of such excess funds on the basis of (capped) compensation during years of participation in the plan. But any non-discriminatory distribution should be acceptable.