What are the implications of a state audit regarding W2 vs 1099 classification?

March 11, 2026

by a searcher from Yale University - School of Management in New Haven, CT, USA

I'm currently looking at a company in the Medical Staffing industry (locum tenens) and learned that there was currently an audit going on with the state Employment Security office regarding employee classification in a past operating year. When I heard about this, I assumed that the implication of unfavorable results would be that the company would be forced to convert its 1099 contractors to W2 employees (which would obviously have a big impact on the business and its valuation). The owner has mentioned that the burden would simply be a payment to the state of owed taxes per employee from that year. Is my concern about long-term effects on employee classification at the company valid or would it more likely be a simple one-time fee paid to the state? Any guidance from folks with experience in this area would be greatly appreciated!

Reply by a professional
from Loyola College in Maryland in St. Louis, Missouri, United States

Thanks for the tag, ^redacted‌. Your concern about longer-term implications is valid. Even if the immediate outcome of the audit is simply back taxes and penalties, the bigger underwriting question is whether the underlying classification model itself is sustainable going forward. In situations like this I’d want clarity on a few things: • whether the state is specifically challenging the contractor model or just prior tax treatment • whether other states where the company operates (if applicable) could take a similar view • how dependent the economics of the business are on maintaining the 1099 structure As you likely know, if regulators ultimately determine the workers should be W2 employees, that can affect not just payroll taxes but benefits, insurance, and operating flexibility — which obviously flows through to margins and valuation.

Reply by a searcher
from University of Wisconsin in United States

DM me and I'd love to chat. I recently encountered a similar issue

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