When You're Most at Risk of Payroll Fraud and How to Prevent It

Introduction

Payroll fraud is a common case of malpractice in the corporate world. Payroll fraud can make you lose money and cause many problems with law enforcement agencies.

A 2022 Global Economic Crime and Fraud Survey shows that about 46% of companies reported payroll fraud cases within the past two years.

Two categories of people commit payroll fraud: intentional and ignorant perpetrators. Regardless of the category, the penalties are equally severe.

You probably want to avoid involvement in payroll fraud but aren't sure where to begin. This article can help. Read on to find out how to identify the signs and prevent payroll fraud in five steps.

What is payroll fraud?

Payroll fraud occurs when an employer or employee illegally earns more than they should or enjoys certain benefits through the payroll processing structure. Both employers and employees can be guilty of payroll fraud. For employees, resentment toward the company, dissatisfaction with their wages, and greed are major reasons for payroll fraud. Meanwhile, employers may use it to lower hiring costs, pay lower taxes, or increase their net income.

The payroll fraud rate in small businesses is twice as high as in large corporations. Like any other form of corporate crime, this practice is illegal and comes with penalties. Punishment for this crime depends on the severity of damage the perpetrator caused and the amount they stole. Perpetrators could face time in jail, get hefty fines, or both.

Besides the legal fines, a business or individual drags their reputation in the mud by participating in fraud. Consequently, some corporations cut ties with them, stakeholders stop investing, and customers may stop patronizing them.

Payroll fraud risk and types of payroll fraud

You have a chance to avoid payroll fraud if you can recognize it. Here are the common payroll frauds and payroll fraud risks you may encounter:

Misclassification

This occurs when an employer hires employees and independent contractors and manages them the same way. The labor code distinguishes between employees and independent contractors, and there should be a clear distinction in how both workers operate.

Some employers may choose to have contractors function as employees. They pay little or no taxes, avoid benefits and underpay workers. Depending on the region, penalties range from heavy fines to prison sentences.

Hyped expenses

This scam occurs between employees who conspire to make more money off the company. The accounting and payroll staff often connivance with another employee in charge of buying supplies or heading a project. They write significantly high quotes and keep the change. Management rarely checks these expenses.

Personal expenses

This is one of the most challenging payroll frauds to detect and curtail. Employees in executive positions, such as CEOs and departmental heads, can be guilty of personal expenses fraud. On official duty, the company pays for its executives' travel, food, and hotel expenses in many top organizations.

Sometimes, these employees have unique credit cards charged to the company account. However, some use these cards for official and personal outings or expenses.

Boosted numbers

This is another way employees try to rip off the company. In cases where a company pays its staff according to the numbers they do weekly or daily, some may alter those figures. This is common in sales and other occupations where employees may have ridiculously high targets.  

Ghost (non-existent) employees on payroll

A "ghost worker" is an employee who only exists on paper and is on the payroll. Many were never the company's employees. Some former employees may still be on the payroll.

Usually, shady payroll employees are culpable. They purposely include fake profiles on the payroll and disburse wages to them and actual employees. Meanwhile, they receive the wages along with theirs.  

False billable hours

Employers in the United States and many other developed nations pay by the hour. Thus, they calculate wages at the end of the week by multiplying each employee's hours by the hourly rate. To earn more wages while working fewer hours, employees falsify timesheet data. They commit this offense by logging in false hours or making their colleagues fill in for them in their absence.

False sick leave

Employees apply illegal techniques to earn more money while working for an organization, such as falsifying sick leaves. Sick leave fraud is one of the trickiest payroll schemes to eradicate.

Although every employee has a right to sick leave, this only applies when genuinely ill. Meanwhile, some employees may take this paid leave to work elsewhere, earning twice their salary.

Commission and benefits fraud

Employees may benefit from any physical or emotional harm they sustain at work. Knowing this, some may falsely claim to be victims to get bonuses. For example, some factory workers may falsely claim to suffer injuries from work tools for benefits such as paid leave or cash bonuses.

Pay rate falsification

Employees may conspire to increase their pay rate on the payroll. This automatically makes them earn more than they should. The payroll employee usually gets a share of the profits when they receive their paycheck.

Not reporting overpayment

Errors resulting in overpaying wages are significant payroll risks that cause companies to lose money. Sometimes, employees receive more than their wages; in most cases, they never report it. Over 13.6 million Americans admit to receiving more than their wages, but not all were in a hurry to report it.

Reporting this error to management would help the company avoid overpaying employees, saving them money. According to the Federal Labor Standards Act (FLSA), employers can recover overpaid wages legally. The FLSA considers overpayment as an advance on the employee's wages which they can deduct. However, companies rarely charge employees for not reporting overpayment of wages.

How to prevent payroll fraud

Payroll fraud can harm a company's earning potential and ability to compete financially with competitors. Fortunately, preventing this fraudulent occurrence is possible if you implement strategic systems. Here's how you can avoid payroll fraud in your organization:

1. Install attendance software

Employees have multiple ways of evading superiors, especially when they log in manually. Upon installing these systems, employees can only access the building with their biometric data, such as the retina or fingerprint. Meanwhile, the system records these activities each time the employee moves in and out of the premises.

Time management software can enable employers to track their log-in time for remote workers. Some of these tools also allow superiors to view what the employee has on their screen in real time. This makes it difficult to falsify working hours and makes it easier to calculate payroll.

2. Perform internal payroll audits

Payroll audits are compulsory if you want to catch fraudulent activities in payroll. This is usually a reactive approach to suspected cases of payroll fraud. It can also be a proactive measure to prevent any attempt to defraud the company.

Although you may have internal auditors, you want to eliminate the risk of falsifying audit reports. Hiring an external auditor is the better option. Besides objectivity, they also provide an outside-in perspective on your business.

3. Classify workers correctly

The simplest way out of misclassification issues is to classify your workers correctly. Clearly distinguish employees from contractors from the outset. Sometimes the significance of a contractor's role can blur the misclassification lines.

Thus, clearly define each person's responsibilities, wages, benefits, and the applicable rules. Ensure the same punctuality, dress code, or scheduling regulations don't apply to employees and contractors.

4. Manager review

You may need to allow managers to review timesheets, leave requests, and bonuses. Ensure that payroll staff can only make payments upon approval from superiors. Managers should also review payroll reports after a payment bucket or cycle. That way, they can be sure that the recipients' data matches the employees working in the company.

5. Modify policies and procedures

When you discover a trend of payroll fraud, perhaps you need to look at your policies. Check for loopholes. You may rewrite your company code to make sure your policies are air-tight. Create a company policy that thrives on transparency and accountability. You may need to retrain staff and install new technology. Although this increases your spending, it can save you more long-term.

Enable global payroll fraud prevention with a payroll platform like Skuad

One of the easiest ways to avoid payroll fraud is to partner with a global employment and payroll platform like Skuad. By working with a payroll platform like Skuad, your organization can enable maximum protection against payroll fraud.

We offer a transparent and 100% compliant approach to payroll management. Book a demo to learn how we can help you achieve a future without payroll fraud.