7-min read Feb 24, 2022

How To Avoid Payroll Fraud And Scams

How To Avoid Payroll Fraud And Scams

Payroll fraud and payroll-related scams are far more common than most consumers and businesses realize. In fact, more than one out of every four businesses are affected by payroll frauds and scams. There are many different types of payroll frauds, but some of the most common payroll frauds can occur with little to no warning. If left unaddressed, these scams could end up costing your business tens of thousands of dollars (if not more) every year.

So, what are the most common payroll frauds? What differentiates the various types of payroll frauds? Most importantly, what can you do to prevent, detect, and combat payroll frauds and scams for your business? We will answer all of these questions and more, but first, let’s look at exactly what payroll fraud is and how it can negatively impact your business.

What Is Payroll Fraud?

Payroll fraud is a type of scam in which an individual or organization uses a company’s payroll system to embezzle funds. In many cases, an employee of a company with knowledge of the payroll system can find loopholes to initiate a payroll scam. In other cases, an entire company can use falsified information to commit payroll fraud schemes and funnel money to one or more individuals inside or outside of the company.

In essence, payroll fraud is just another form of stealing. Since payroll systems can be complex, it is often relatively easy for someone to take advantage of the situation and steal funds to which they are not entitled. Payroll fraud also allows companies to misdirect funds for the sake of avoiding taxes, underpaying employees, or otherwise misrepresenting the funds moving through the organization.

However, this still might leave you with a pretty vague sense of what payroll fraud actually means. In practice, there are dozens of different types of payroll frauds. The most common types include ghost payroll, payroll manipulation, and direct deposit fraud. We will take a closer look at each of these fraud types below:

Ghost Employee Fraud

Ghost employee fraud can be carried out by an individual or an entire organization. In essence, a company’s payroll reports a salary going to an employee that doesn’t exist. This kind of “ghost payroll” enables accomplices to misappropriate company funds and, in most cases, take the reported salaries for themselves.

A ghost employee scheme can be initiated in several different ways. For example, a completely fake persona could be created to act as a ghost employee. Alternatively, former employees could act as ghost employees for payroll, so that a company could act as though it were still paying workers who actually no longer work for the organization. This could even apply to employees who have died.

If you’re worried about ghost payroll fraud occurring in your business, you simply need to do an audit of your payroll and your staff. If there are any discrepancies or red flags, you will need to do an internal investigation to see if anyone is using the payroll system inappropriately.

Payroll Manipulation

There are essentially two primary forms of payroll manipulation; manipulation committed by an employee or manipulation committed by an employer. Either way, payroll manipulation is exactly what it sounds like: the numbers or information reported in the payroll system do not correspond to actual payments made or hours worked.

For example, timecard manipulation is one of the most common forms of payroll fraud committed by employees. This simply requires an employee to report more hours to payroll than they actually worked. Not only would this result in higher unearned payments, but it could also result in unearned overtime pay and bonuses. Consequently, it is very important to ensure that your employees report their hours worked as accurately as possible. Most businesses have to institute a system that keeps tight control over how employee time and labor are reported to avoid this kind of issue.

Similarly, employees paid on commission can report higher sales numbers to collect unearned commissions. Thus, a commission scheme is a type of payroll fraud that is most often associated with sales departments. However, any kind of employee who is paid on commission could theoretically embezzle company funds by misreporting information related to sales numbers.

Finally, businesses and employers can commit payroll manipulation through timecard manipulation or similar payroll scams. Rather than overreporting time worked, businesses will underreport earned income so that they can pay less to employees and the IRS on those earnings. This is an unethical but sadly common practice in which employers often find loopholes or illegitimate reasons to deduct wages from employees. However, as long as your employee’s salaries and labor are reported accurately, you don’t have to worry about committing this kind of fraud.

Direct Deposit Fraud

Nowadays, most businesses pay their employees with some form of direct deposit. This ensures that employees can automatically get their salary payments without having to deposit physical paychecks or deal with cash. While direct deposits are one of the safest and most efficient ways to distribute salaries throughout an organization, they can be manipulated by a third party to commit payroll fraud.

Direct deposit fraud is also known as “payroll diversion.” While there are various ways that this can be done, payroll diversion generally requires someone to falsely change the direct deposit information of a company’s employee to divert the funds to a different account. If your business does not have a system in place to authorize and validate changes in direct deposit information, you could leave yourself open to direct deposit fraud.

A common way for criminals to commit direct deposit fraud is through a payroll phishing email. When this happens, a third party sends an email to your payroll department pretending to be an employee. The email claims that the employee would like to change their direct deposit information. If the person fielding payroll emails does not actually follow up on this request with the employee in question, they could inadvertently divert company funds to an unknown person. Not only would it be complicated and expensive to get this money back through legal action, but it could also cause issues for the employee who suddenly stops receiving their earned salary.

What To Do If You’ve Fallen Victim

Once you’ve fallen victim to payroll fraud, you may have no choice but to either accept the losses or take legal action against the perpetrator(s). In the meantime, you will want to protect your business from any future issues and find ways to deal with payroll scams going forward. Here are some of the best methods to use:

  • Payroll Anomaly Detection – Every payroll department should have an automated system that looks for strange occurrences, unauthorized payments, or similar anomalies. This will greatly reduce the risk of payroll fraud and help you address potential scams in real-time.
  • Background Checks – When hiring new employees, it is always best to do a background check. While this does not completely eliminate the risk of payroll fraud, it could help you identify and avoid candidates who have a history of defrauding or embezzling funds.
  • Payroll Audits – In addition to automated payroll detection systems, it’s also good to hire an extra set of eyes to comb through your payroll. This can help you identify ghost employees or potential payroll scams as quickly as possible.
  • Payroll Funding – If you’ve already fallen victim to payroll fraud, then you have already lost money to a scammer. This could mean that you do not have enough funds to cover payroll. Fortunately, payroll funding can help you cover your current payroll while you deal with any fraudulent payments.

Have you recently experienced payroll fraud or scams at your business? If so, payroll funding could be the right short-term solution for you. To learn more about the advantages of payroll funding, feel free to reach out to Payro Finance today!

Morris Reichman


Morris Reichman is the founder and CEO of Payro Finance. Former Vice President at Infinity Capital Funding an alternative finance company, Morris possesses a versatile background in the finance industry. Having spent 7+ years working across global macro operations and start up corporate finance Morris's expertise is in business accounting, risk management and investment analysis. Morris founded Payro Finance to support business owners and ensure their business continuity.

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