1. Be prepared for the audit with documentary proof. 2. Sue the former employee for damages including damage to your business reputation. 3. See if filing a false report with the Dept of Labor constitutes a criminal act. If so, press charges. Good Luck!
Labor & Industries auditors can be very difficult to deal with and in my experience tend to treat all taxpayers as criminals, especially as it relates to the classication of an individual as a "covered worker," which can include independent contractors as well as employees. Regardless of what common sense would suggest, a person can be treated as a covered worker for L&I and unemployment even though they are otherwise independent contractors.
The rules are complex and often will come down to a determination of whether or not the business exercise control over the independent contractor's provision of services. From a practical standpoint, when the independent contractor works exclusively for a business, as opposed to working with multiple businesses, that person will often be classified as a covered worker subject to workers compensation and state unemployment.
It is doubtful that you have any cost effective legal remedies against the disgruntled independent contractor. I would urge you to keep a record of any communications with the independent contractor and urge you not to meet with this person, except in the presence of other corroborating witnesses.
As for dealing with L&I, I would suggest that you initially attempt to handle this matter directly yourself. If you have timely filed your reports and the issue is only related to the status of this independent contractor as an employee, the premium liability may not make it worthwhile to obtain professional assistance. Provide the auditor with records regarding the hours worked by employees and your completed filings. Provide information regarding the hours worked by the independent contractor and provide any contracts or other information that you might have regarding the nature of the relationship with the independent contractor, including invoices for services, etc. Be sure to keep copies of everything that you provide to the auditor and ask that any requests for additional information be specified in writing. Keep your answers short and to the point.
I would contact an attorney who has experience dealing with Administrative agencies as soon as possible, to learn more about the process and what you can expect moving forward.
Legal disclaimer: I am licensed to practice law in the state of Washington and the answer provided above is for general information purposes only and should not be relied on as specific legal advice. This answer does not form an attorney-client relationship. You should consult with an attorney of your choice to fully advise you about your legal rights and obligations.
What you consider an "independent contractor" and what L&I considers and independent contractor can and probably does look much different. It is extremely hard to prove that a worker for you doing what other employees would do is working as an independent contractor and even bartering for services is considered under L&I.