I took a 401K withdrawal at age 59 1/2 in 2008. I did not report it on my 2008 income taxes but did report it on my 2009 taxes. I was told by a friend that I had two years to claim it. Now I have received a Notice of Deficiency from the IRS. I do not want to pay as I have claimed this. What should I do.

If you took the withdrawal in 2008 then it was '08 income to you and you owed taxes on it to be paid with your 2008 return (in April 2009). You should have received a 1099-R form for tax year 2008 that reports this as income for '08. So now you will have to acknowledge the discrepancy with the IRS and pay the taxes owed plus interest. You should also file an amended return for tax year 2009 to remove the amount you mistakenly reported for that year, which will give you a refund for '09. Unfortunately you have to be the banker for all this - you can't just apply your refund for '09 to the amount you owe for '08, but rather will have to come up with the cash to pay the amount you owe for '08.