If you’ve kept up with recent news, you likely know that Uber is facing a class-action lawsuit for potentially mislabeling employees as independent contractors, which is against the U.S. labor laws. Meanwhile, FedEx has recently settled in a similar lawsuit for $228 million. As one of the largest employment law settlements in recent history, this sends a clear message: companies that misclassify workers can be financially punished—and the cost could be catastrophic.

Unfortunately, many owners of small and medium-sized businesses think they are immune to these types of consequences. But the truth is the feds are cracking down on misclassification of independent contractors and no company is above the labor laws of the country. Properly labeling your workers should be a priority.

Why Is Classification such an Important Issue?

Though the labor laws have not changed in decades, the rise of the contingent worker in the United States has forced the government to take action against companies that mislabel employees. With more organizations employing consultants, interns, independent contractors, and freelancers than ever before, misclassification is becoming more prevalent.

The Fair Labor Standards Act (FLSA) was established to set regulations for minimum wage, overtime pay, recordkeeping and other employment factors, but it only applies to employees, not independent contractors. Therefore, companies that misclassify workers are essentially taking rights away from their workers, which the U.S. government does not take lightly.

Some of these rights include overtime pay, rest periods, meals, health coverage, pension plans, workers’ compensation, and unemployment insurance. If you do not provide these rights where applicable, you will not be performing your obligations as an employer, and will be penalized if you are found to be misclassifying under labor laws.

The Tricky Question: Who Is an Employee?

Organizations may purposely misclassify employees as independent contractors in order to avoid the hassles of dealing with labor laws and paying for overtime, expenses, etc. However, others may do so unintentionally because the term “employee” isn’t well defined. It is often up to subjective interpretation based on the unique employment situation. However, common law tests have been developed by various tribunals and courts to determine who exactly is an employee and who is a contractor.

Generally, these tests look at five factors, though determination could still be unclear depending on unique circumstances. These five factors include control, ownership of tools, chance of profit or loss, integration, and payment. The whole picture needs to be considered, however, as none of these factors on their own are determinative.

A Contract Isn’t Enough

Even if you and the worker have both agreed to a contractor relationship, it isn’t enough. A written contract between the employer and the worker will not stand up in court if an audit or lawsuit arises. A variety of federal and state agencies, including the Internal Revenue Service, can challenge the label and reach their own determination.

The Consequences

The financial liability of misclassification under U.S. labor laws could be tremendous. They could sink your company. You will be forced to remit all of the deductions you should have been making from the employee’s pay to the government, from the date, the contributions were due. You will also have to pay any penalties and interest fees that apply. Additional payments, such as vacation, sick time, overtime, and expenses may also need to be provided to the employees in question, plus any imposed penalties.

The misclassification of independent contractors can also come with a bad reputation in the industry—making it less likely that clients and talented job seekers would want to work for your company.

Worker classification can be complex. However, it is vital that, as an employer, you get it right. To ensure compliance with labor laws, consider engaging an employment consultant or outsourcing your payroll to a managed services provider that has the knowledge and experience needed to make the correct call.