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Payroll Fraud Can Happen to Any Business if You're Not Careful


Payroll fraud is one of the leading forms of employee theft and accounting deception in businesses across the U.S. In its 2014 fraud report, the Association of Certified Fraud Examiners (ACFE) noted that this type of fraud occurs in 27 percent of all businesses, with nearly twice the frequency in small businesses with fewer than 100 employees (16.5 percent), than in larger businesses (8.2 percent). Making matters worse, payroll fraud can fester for an average of 36 months, and small businesses are most adversely affected. They are, "taking a median hit of $154,000, even higher than the median $145,000 for all businesses."

The three most common types of payroll fraud are:

Timesheet Fraud

When employees falsify their timesheet submissions and get paid for hours they don't work, businesses lose money. In some cases, employees arrange for a co-worker to clock in and out for them when they're not working. Another common timesheet scheme involves a payroll clerk who manually overrides an employee timesheet, adding hours to increase payment.

Ghost Employees

A ghost employee may involve "fake" employees who never worked for a business but have been manufactured to divert funds, "or someone who once worked for the company and has since left, but was never officially terminated in the payroll system."

Worker Misclassification

Someone who works for your business must be classified either as an employee (Form W-2 recipient) or an independent contractor (Form 1099 worker). Employers sometimes misclassify workers by accident, but others may do so intentionally with the goal of avoiding payment of unemployment tax, payroll taxes, or workers' compensation insurance. This is fraud and can be punishable by law.

Addressing Payroll Fraud

Experts contend that one of the most effective solutions to help prevent fraudulent behavior is separation of duties. An individual who's responsible for processing payroll should not also be responsible for entering changes or amending employee records.

Another wise move would be to reconcile payroll on a regular basis. "The key is catching [payroll fraud] and minimizing the risk," states Matthew Garrett at Forbes. The best way of doing so, he contends, “is to reconcile your payroll at least quarterly with someone other than the person who runs your payroll."

An increasing number of small businesses are opting to work with a payroll service provider that offers the flexibility to report payroll information over the phone or email or to enter payroll information yourself. By outsourcing payroll functions to a reputable service provider, their technology and flexible service options can help free up your time to focus on running your business. 

But don't rush out and sign up with the first payroll service provider you come across. Like every would-be employee, a provider should be thoroughly vetted before you bring them on board. Here are some questions to ask:

  • Are they a nationally recognized company?
  • Do they have a proven track record of implementing high ethical standards?
  • Are they required to adhere to Securities and Exchange Commission (SEC) regulations?
  • Do they possess a certificate of liability insurance?

There are many decisions to be made when choosing a payroll provider; here are some tips to help you select a service that works for you.


This website contains articles posted for informational and educational value. Paychex is not responsible for information contained within any of these materials. Any opinions expressed within materials are not necessarily the opinion of, or supported by, Paychex. The information in these materials should not be considered legal or accounting advice, and it should not substitute for legal, accounting, and other professional advice where the facts and circumstances warrant.
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