"1099 contractor payment meaning direct deposit via a payroll company, but not as employee"
Direct Deposit is Banking, not "reason" they got paid. Handing this off to a payroll company doesn't make them responsible. The payroll processing company does what the business hires them to do, so they are not the place this went wrong. However, anyone can fix it.
Do the hiring paperwork (State and Fed) for this person.
Treat all payouts as Loaned.
Do "payroll" as year end (if this is for the prior year) or, for 2020, catch it up now. The amount they already is treated as Takehome, so this requires the amount to be Grossed Up. That means you back-calculate what the takehome would be based on and run the Gross through payroll. Then, treat the amount taken as a Payroll Deduction post-taxes, the same as a wage garnishment, only without requiring to forward the funds to an outside agency. If you do this right, the paychecks end at $0 takehome. Do that until all previously taken funds = $0 net, or at the least, until you can prove Reasonable Wages has been met.
Amend all payroll forms impacted. File anything never filed. Pay State and Fed agencies anything never paid, including penalties and interest.
Amend the corporate return. Issue amended K-1.
Amend personal returns.
All of this includes worker comp and any retirement plans, health and benefits where this person now is considered qualified or otherwise is a participant.
It's a lot to review; an HR consultant might be helpful.
"Level Up" is a gaming function, not a real life function.