Coverage Test/Waiver of Participation

Hello, have a unique situation summarized below and curious how to proceed. Any information would be appreciated. 

Plan had 3 employees (2 owners and a non-HCE). The only contributions allow to the plan are a Profit Sharing allocation in which all receive an equal proportion to compensation. This contributions is on a 6 year graded vesting schedule. They have a 1 year of service required of 1,000 hours to which a new employee met. They became eligible based on reaching 1,000 using their anniversary date as their determination period.

The employee did not reach 1,000 in a calendar year and will not meet this requirement at any point. The concern is putting profit sharing money annually when this employee will never meet any level of vesting service would cause frustration with the employee as they will receive a profit share and statement annually while continually having 0% vesting. The client and participant are curious if she is able to put something in writing to opt out or waive the rights to a profit share to avoid this.

Our concern is that since this employee reached eligibility, the plan would fail coverage testing and require a corrective contribution. If the employee has opted out of the plan entirely, would they be owed a QNEC for a failed coverage test or would the opt out from the plan apply?

You'll have a testing failure if you don't cover her.

Plan "may" allow irrevocable election to "opt out" but it must be executed prior to the participant becoming eligible. Though I would recommend against this because you still need to include them in testing and if your only NHCE is receiving $0 and has irrevocably elected out of the plan, I don't know how you fix that testing failure.

Why not just 100% vest her and move on? I mean how much can an employee who doesn't work 1000 per year cost?

There are at least 3 conditions where she would become 100% despite not working 1000 hours in the future -

1 - she attains the Plan's NRA while employed.

2 - she is affected by a Partial Plan termination.

3 - the Plan is terminated requiring full vesting.

There may be others I'm missing.

40 minutes ago, MattHSC said:

The employee did not reach 1,000 in a calendar year and will not meet this requirement at any point.

The wording here confuses me a little - I'm going to assume you mean that the employee met the 1,000 hours of service required to enter the plan in one year, but has not and is not expected to complete 1,000 hours of service in any later year. Otherwise your post does not make sense.

Since the employee has met the plan's eligibility requirements, they will continue to be a participant for as long as they are an employee, and will be non-excludable for purposes of the coverage and nondiscrimination tests. So they have to receive whatever contributions are necessary to satisfy those tests. They could be required to receive a top heavy minimum contribution, too.

Even if they never attain 2 years of vesting service, they could still become vested if they reach the plan's normal retirement age, or if the plan terminates.

The one-time irrevocable waiver of participation would not be of any help in this case, as it a) must be executed before the employee first becomes eligible in any plan of the employer, and b) does not get you a free pass on coverage; the employee who waived participation is treated as non-excludable and not benefiting in the coverage test.

This situation could have been avoided by designing the plan with the 2-year eligibility rule, but it is too late for that now.

Thank you both. This confirmed my thoughts as well. 

3 hours ago, C. B. Zeller said:

The wording here confuses me a little - I'm going to assume you mean that the employee met the 1,000 hours of service required to enter the plan in one year, but has not and is not expected to complete 1,000 hours of service in any later year. Otherwise your post does not make sense.

The OP wording just means that the NHCE worked 1000 hours in the first 12 months following date of hire. But vesting is based on calendar (ie plan) years and the NHCE didn't and won't ever have 1000 hours in that vesting measurement period.