What is Payroll Fraud and How to Prevent It

Payroll fraud, which affects 27% of all businesses, is the main cause of both accounting fraud and employee theft. It happens twice as often in small businesses with fewer than 100 employees compared to large ones. In actuality, occupational fraud, or fraud perpetrated by an employee against an employer, costs businesses more money than fraud done by outside parties.

Dishonest employees frequently engage in lengthy schemes as they try to conceal their theft while continuing to work for their employer. Payroll fraud schemes can span 30 months and cause losses of up to $63,000, according to the Association of Certified Fraud Examiners. Payroll fraud costs businesses money, but it also costs them money in the form of IRS fines after the initial crime.

The first step in recognizing and preventing this is to have a good grasp of the various types of payroll fraud that might occur and the safeguards to put in place to minimize harm. Thus, to get a good grasp of it we are going to discuss what is payroll fraud and how to prevent it. So read on.

What is Payroll fraud?

Payroll fraud occurs when either employees or employers inadvertently exploit the payroll system to either get compensation for services they have not rendered or, in the case of employers, to withhold payment of wages that have been earned legally and for which taxes are owed. Fraud can take many different shapes and can be challenging to spot. If firms aren’t careful, the cost of this fraud and theft may be high.

Most Common Types of Payroll Fraud

Payroll fraud mainly comprises altering employee records, time cards, pay scales, or job categories in order to make unauthorized payments to current or nonexistent employees resulting in financial losses for the company.

Payroll fraud frequently takes the following forms:

1. Ghost employee fraud

It makes reference to adding fictitious or nonexistent employees to the payroll records. These employees’ pay is unlawfully transferred to other employee accounts or stolen in various ways. Large organizations with many employees and shoddy internal controls often have a higher prevalence of it.

The violator may continue to pay a staff person who is no longer working for the company or create a bogus employee. They falsify the employment records in this manner in order to continue getting payments from the business in the form of the ghost employee’s paycheck.

2. Timesheet Fraud

Timesheet fraud is the most typical type of payroll fraud in enterprises. Employees can commit timesheet fraud by padding their work hours by punching in extra hours on the timesheet in order to be compensated for more hours than they actually worked.

Additionally, they might gain access to the payroll system to boost their hourly pay rates and misrepresent their salaries.

3. Wage Theft

It is a payroll fraud committed by the employer where employees are in fact paid less than the legally required minimum wage in order to meet compliance standards. Other types of wage theft include illegal deductions, off-the-clock violations, and other practices.  Measuring pay fraud can be challenging since it can take many different forms and because compliance issues aren’t always documented or acknowledged. All low-wage workers combined—across all demographic groups—are impacted to a degree of 17%.

4. Misclassification

Employers place their employees in several categories based on the number of hours they put in, how they interact with the business, and other considerations. For instance, you might classify someone as an independent contractor, a full-time worker, or a part-time worker.

Different types of employees have different advantages available to them. Employers occasionally misclassify workers to avoid paying items like payroll taxes, unemployment taxes, and employee benefits. Payroll fraud, which includes intentional misclassification, can have legal repercussions for the company.

5. Payscale Alteration

In this payroll scam, employees’ grades or hourly rates are changed to make them eligible for higher compensation than they are legally entitled to. This fraud was made possible by employee cooperation with the payroll and human resources (HR) departments.

Ways to Prevent Payroll Fraud

Payroll fraud cases can be considerably decreased with adequate payroll systems and efficient oversight.  The solutions given below will make sure that only verified workers are paid and will spot any irregularities in the payroll system.

• Effective Oversight Mechanisms

You should have oversight in the form of the requirement for a top executive’s permission for commission checks and overtime payments.

There should be a process in place for quarterly and annual payroll book reconciliation. You should also hire a third party to examine your payroll data in order to look for ghost workers and other instances of payroll fraud.

• Roles Segregation

You should clearly define the responsibilities of HR and payroll because the HR professionals who register new employees in the system shouldn’t be engaged with processing payroll or reconciling payroll data.

Integrating a payroll solution with an HCM suite ensures a smooth data flow and error-free payroll processing. Additionally, it assists in maintaining data integrity and guards against any unauthorized changes to employee records.

• Limited Access to Payroll Information

Payroll information should only be accessible to those employees who perform essential duties for processing payroll. The role-based access will enable you to keep payroll information private and secure while also ensuring data privacy.

Payroll systems with AI and machine learning skills can detect abnormalities. The security features prevent any unauthorized access to the employee data.

• Outsource Payroll Processing

You can enlist the aid of a reliable payroll service provider to assist you in lowering the risk of payroll theft. Their technological solutions, which make use of artificial intelligence (AI) and machine learning (ML), can help your organization avoid financial loss by quickly detecting fraud.

In Conclusion

Payroll fraud can financially impact your business, especially in industries where the cost of hiring employees is high. Therefore, it is critical for your business to foster a culture of integrity and values in order to lessen instances of employee theft committed through payroll manipulation.