Payroll is often an employer’s biggest expense, making it a prime target for fraud on many levels. Employers, employees, third parties, and others all contribute to payroll rackets.

How employers engage in payroll fraud

Paying under the table

The employer pays the employee in cash “off-the-books” in order to skirt their employment obligations.

For example, by paying under the table, the employer illegally avoids paying federal and state taxes for the employee. Some employers pay under the table to get away with hiring undocumented workers, or to avoid purchasing mandatory insurance — such as workers’ compensation.

Misclassifying employees as independent contractors

This type of misclassification strips the employee of their labor rights, as independent contractors are not protected by most employment regulations, including minimum wage and overtime pay laws.

By committing payroll fraud, an employer could face audits/investigations, civil money penalties, and imprisonment.

Employees and their payroll schemes

Timecard fraud

A common type of timecard fraud is when employees falsify their timesheets by padding their number of hours worked. In addition, there’s buddy punching, where an employee arranges to have a co-worker clock in and/or out for them while they take time off from work.

Employers can reduce timecard fraud by adopting strict protocols for reviewing employees’ time records. Some employers utilize a biometric timekeeping system, which identifies the user based on their unique physical or behavioral attributes — such as fingerprints, face, palm veins, or voice patterns.

Ghost employees and commission fraud

With the ghost employee scam, a member of the payroll team establishes a fake employee record for an employee who has already left the company but was never terminated in the payroll system.

Sometimes, the fake/ghost employee is someone who hasn’t worked for the company at all. Either way, wage payments are administered under the ghost employee but are actually received by the perpetrating payroll team member.

As for commission fraud, sales employees are the most likely offenders. For instance, to meet their sales goals, the employee might ship certain products to a customer even though the customer never ordered the items.

Employers can combat ghost employees and commission hoaxes by frequently conducting payroll audits, verifying pay authorizations, and promptly investigating red flags.

Instead of giving one person sole authority over their payroll, employers should segregate payroll duties and delegate strong oversight. They should also develop airtight commission policies and procedures that leave no room for exploitation.


Case in point:

A Washington, D.C., postal worker received nearly $40,000 in unearned wages from the USPS over the course of 144 days by claiming that he was serving jury duty in an extended federal trial. He was dismissed before the deliberations started, but reportedly told his supervisor that he was still on jury duty, just so he could keep getting his regular salary from the USPS. He also fabricated court paperwork to justify his reimbursement claims.

Employers should closely inspect submitted proof of jury duty, and, if allowed by the state, contact the court to verify whether jury duty was actually served.

Third-party payroll fraud

Payroll outsourcing schemes

The arrest of Michael T. Mann, CEO of MyPayrollHR — a cloud-based payroll processing firm — is a sober reminder that not all payroll outsourcing companies are ethical.

Following an FBI raid, Mann was arrested and charged in a $70 million bank fraud scheme. MyPayrollHR closed abruptly, “leaving about 8,000 people at some 400 companies without their paychecks — and $30 million unaccounted for,” according to an article published by Business Insider.

Salient takeaway: Employers must be judicious when handing over their payroll responsibilities to a third party.

Phishing scams

The IRS often sends out alerts, warning employers and employees about phishing schemes, such as W-2 scams, direct deposit scams, identity theft, and wire transfer theft.

To combat these threats, employers must:

  • Stay abreast of new developments on phishing scams.
  • Implement durable HR, payroll, and financial cybersecurity controls.
  • Educate employees on the different of types of phishing scams and how to combat them.
  • Provide focused cybersecurity training to the HR, payroll, and finance teams.

COVID-19-related payroll fraud

Cybercriminals have reportedly targeted recipients of the federal Paycheck Protection Program (PPP), which is designed to assist small businesses struggling to meet their payroll needs because of COVID-19.

Further, two businessmen were charged with allegedly filing fraudulent PPP loan applications. According to the Justice Department, the two businessmen claimed “to have dozens of employees earning wages at four different business entities when, in fact, there were no employees working for any of the businesses.”

With payroll fraud attacking from so many sides, everyone must practice vigilance.