DOL audits are increasing and many times it is the DOL that will uncover and address the issue.
The Other Audits for Employers - Barbara Weltman
And yes, Kirby is right on the possible tax audit of the former 1099 employee. Should get a refund on SE taxes but could owe more income taxes once the business write offs are denied.
I had a client several years ago that was trying to qualify for a DI policy. Gross income just shy of $300k. Net after business expenses $20k.
He drove a bread truck for a local bakery, delivering to grocery and convenience stores. Actually BOUGHT the bread at wholesale then marked up and sold to stores. Packages were pre-priced for retail. His truck. His gas. His maintenance. His inventory.
I don't know why he didn't get a regular job. Required him to get up at oh-dark-thirty and deliver. Back home in time to take the kids to school.