What is payroll fraud? An introduction to payroll fraud

There are many ways to steal from an individual or organization. When you think of stealing, you probably imagine shoplifting, robbing banks, and breaking into homes. But those are only a few of the ways that someone can steal. One of the most common ways for people to commit theft in the workplace is through payroll fraud.

Payroll fraud occurs when an employee or employer manipulates a payroll system to take money they’re not entitled to. From misclassifying employees and padding hours to using ghost employees, payroll fraud takes on many forms, all of which threaten small businesses. In fact, payroll fraud is two times more likely to happen to small businesses when compared with large organizations.

In this article, we’ll take an in-depth look at what payroll fraud is and explain different payroll fraud schemes. Perhaps most importantly, we’ll give you tips for how to prevent payroll fraud in the first place. Read on to learn more about the causes of payroll fraud and how it’s detected, or use the links below to navigate the post.

What is payroll fraud?

Payroll fraud is when an individual illicitly alters a payroll system to manipulate employee compensation. It’s a crime that can be committed by both employees and employers.

Employees can commit payroll fraud by clocking hours they don’t work or secretly increasing their compensation rate. On the other hand, employers can commit payroll fraud by withholding wages and benefits that they owe their employees. In either case, one party is being deceitful and stealing from the other to enrich themselves.

What is considered payroll fraud?

As we mentioned above, payroll fraud presents itself in a variety of forms. Some methods of payroll fraud are easier to detect than others. Below, we’ll look at some of the most common types of payroll fraud.


Employers give their employees different classifications depending on the number of hours they work, their relationship with the company, and other factors. For instance, you may classify someone as a full-time employee, a part-time employee, or an independent contractor.

Employees with different classifications are entitled to different benefits. In some cases, employers may misclassify employees to save on things like unemployment taxes, payroll taxes, and employee benefits. Intentional misclassification can be considered payroll fraud, which in turn can result in legal consequences for the employer.

Timesheet fraud

Timesheet fraud, also called buddy punching, is when employees manipulate their timesheet to make it appear as if they worked more hours than they actually did. Generally, there are two ways this happens. First, employees may pad their hours on the timesheet by clocking extra hours they didn’t work. Or, secondly, employees may access the payroll system to falsify their wages and increase their hourly pay rate.

Commission schemes

Some employees may receive bonuses or commissions when they make sales or hit milestones. These bonuses act as an incentive for employees to work hard and excel at their jobs. However, sometimes employees may figure out how to award themselves commissions or bonuses they didn’t earn. This is known as a commission scheme and is typically punishable as payroll fraud.

Workers’ compensation fraud

Workers’ compensation fraud is when an employee fakes an injury or falsely claims they got injured at work to collect workers’ compensation. Being a self-insured company can directly impact its finances. Alternatively, this type of fraud can cost an insurance company a lot of money, which in turn can prompt them to raise their premiums.

Ghost payroll

The term ghost payroll refers to situations in which companies are unwittingly paying nonexistent employees. This type of payroll fraud is most often committed by a human resources employee or someone with easy access to the company payroll system. The perpetrator can create a fake employee or keep a staff member on payroll who no longer works for the company. By falsifying employment records, they can collect the ghost employee’s paycheck as if it were their own.

Third-party scams

While payroll fraud is often committed internally, it can also be committed by external parties. W-2 scams and payroll diversion schemes involve third-party perpetrators who target individual employees or company records.

In a W-2 scam, a cybercriminal tricks employees or HR workers into handing over sensitive employee information, such as their income and Social Security number. They then use this information to file fraudulent tax returns.

Alternatively, in a payroll diversion scheme, cybercriminals trick employees into changing their direct deposit information. This way, scammers can divert employee paychecks into their own accounts. They may accomplish this scam by sending fraudulent emails or hacking directly into a company’s payroll system.

How is payroll fraud detected?

If a payroll fraud scheme is taking place, it’s usually uncovered at some point or another. However, some forms of payroll fraud can be very difficult to identify, meaning they can go on for a long time. In fact, according to the Association of Certified Fraud Examiners, payroll fraud schemes last for an average of 24 months.

Typically, there’s no single thing that’s going to serve as a surefire indicator of payroll fraud. However, a few red flags to watch out for include:

  • Errors or gaps in payroll records
  • Changes in payroll records that you did not make
  • Employees who list identical addresses or bank account details
  • Unexpected emails concerning payrolls you didn’t submit

These are just a few of the warning signs to watch out for—remember, payroll fraud can take many forms. That’s why you should review your company’s payroll and accounting records on a regular basis. With QuickBooks Payroll, all of your payroll information is in one place, making it easy to review records and look for irregularities.

Can you sue for payroll fraud?

If an employee or employer commits payroll fraud, they can open themselves up to a lawsuit . The party that’s been victimized can often sue to recover the money that was stolen from them. These types of cases are often subject to state labor laws, so contact a local lawyer if you’re considering a payroll fraud lawsuit.

If you’re an employee who’s had your wages illegally withheld by an employer, you may be entitled to back pay . However, it’s important to act quickly if you discover your employer is committing payroll fraud. In general, the statute of limitations is two years for unintentional wage violations and three years for intentional wage violations.

Is payroll fraud a felony?

Since payroll fraud can take on various forms, it can also have different levels of severity. Whether or not a crime is a felony also depends on the laws where the crime was committed. Generally, the more money a fraudster steals, the harsher the legal consequences are.

How to prevent payroll fraud

As with many other things, when it comes to payroll fraud, prevention is better than the cure. Getting into legal battles, contacting authorities, and attempting to recover stolen money can make for difficult—and expensive—situations. When you put measures to detect and mitigate fraud, you minimize the chances you’ll have to deal with a legal headache later on.

That said, here are some ways small businesses can fight payroll fraud:

Step one: Understand employee classification

As a small business owner, you can face serious penalties for misclassifying your workers. Therefore, it’s important to do some research to find out how to properly classify your employees. Refer to the IRS’ Employer’s Supplemental Tax Guide for worker classification guidelines, or fill out Form SS-8 to get the IRS’ own judgment.

Step two: Mitigate timesheet fraud

Provide workers with clear guidelines about when they can and cannot clock into work. You may even implement identity verification measures, such as an ID card or a fingerprint. And, of course, assign managers to review and sign off on employee timesheets each pay period.

Step three: Watch for commission schemes

Make sure to review your company’s commissions policy on a regular basis. In addition, keep an eye on the records of the employees earning the most commissions. You might even consider auditing their sales to ensure they’ve earned all of their commissions.

Step four: Look for workers’ compensation fraud

First, create a clear policy for reporting workplace injuries. Let employees know who to report injuries to, as well as when and how to report. Also, install security cameras so that any potential workplace injuries are recorded.

Step five: Avoid ghost payroll

A simple solution to this scheme is to physically deliver checks to employees. If this is inconvenient, you can also periodically review your payroll roster and address discrepancies. Look for things like duplicate addresses and account numbers, and ask your bookkeepers about payroll fraud.

Step six: Keep an eye out for third-party scams

Hackers and scammers are a persistent threat to small businesses. To prevent these schemes, educate your staff about common phishing scams. You might also upgrade to a secure payroll system like QuickBooks Payroll. With our payroll processing software, you can easily manage payroll while keeping your staff’s information safe from malicious third parties.

Streamline your payroll and reduce your risk of fraud

Payroll fraud isn’t unique to any one type of business. It can happen to businesses both small and large, in any industry or sector. And, once it occurs, it can be a huge hassle for everyone involved. Money can be stolen, privacy can be invaded, and databases can be compromised. That’s why it’s always best to prevent payroll fraud before it happens.

By knowing how payroll fraud is done and following the fraud prevention tips in this article, you can keep your company safe. You can also minimize the risk of payroll fraud by using QuickBooks Payroll . In addition to being easy to use, our payroll software is secure, private, and thorough. Our staff monitors the service for issues around the clock, 24/7, so that we can protect your sensitive data. With top-tier protection and easy-to-use internal controls, you can run payroll with complete peace of mind.

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