1099 Misclassification Issue - Any Recommendations?

January 22, 2026

by a searcher in United States

I'm working through an issue on an acquisition that's under LOI where the company has misclassified its employees as 1099 contractors where they should instead be W2 employees. This conversion has a significant impact to EBITDA and then ultimately DSCR. I was wondering if anyone has worked through this issue before with a seller. Please comment below and I will reach out.

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Reply by a professional
from University of Michigan in Detroit, MI, USA

Hi Anon, in addition to the EBITDA and DSCR issues you've flag, this issue presents legal risk. The seller has, in effect, has been evading employee related taxes. An asset purchase can help insulate you from those risks. In addition, you should have the seller indemnify you for that specific risk. The seller can't have it both ways--benefiting from the misclassification while he operates the business but not paying the prices when it comes to sell. While you should broach the issue amicably, if the seller refuses to acknowledge and own the problem, you should consider your options. Happy to discuss further. Reach out at redacted and we can set up a time to talk.

Reply by a searcher
from Rollins College in Orlando, FL, USA

Agree with the comments here. I’ve run into this a few times, and the key is to treat it less as a “gotcha” and more as a normalization and risk-allocation issue. In practice, lenders and buyers will underwrite these workers as W-2 regardless of intent, so the EBITDA impact is usually a real, structural adjustment rather than a one-time item, and the bigger question becomes how to allocate the backward-looking exposure (payroll taxes, workers’ comp, wage/hour risk) tied to the pre-close period. What’s worked best for me is getting the facts quickly (who the contractors are, how they’re paid, where they work, how many they are, where they are lcoated, and what the true W-2 run-rate cost looks like), normalizing EBITDA to that reality for DSCR purposes, and then addressing the historical risk separately through a purchase price adjustment, a dedicated escrow/holdback, a seller note that effectively acts as risk capital, or in some cases an earnout if the seller believes margins won’t change post-conversion. Framing the conversation as “this is how lenders will underwrite it, so we need a fair way to bridge the economics and the risk” tends to keep sellers engaged and avoids it turning into an accusation, while still protecting the buyer if the issue is as material as it often is.

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