How to Prevent Payroll Fraud

Payroll fraud is more likely to occur in small businesses than large ones, according to The Chartered Institute of Payroll Professionals, especially in those with under 100 employees. It can lead to loss of money and serious legal consequences for the perpetrators, so it’s important to implement measures to prevent it.

Our years of expertise in the payroll industry means we have the low-down on how to best prevent payroll fraud and protect your business, including (but not limited to) investing in a reliable best payroll solution for your business.

In this article, we’ll go over what payroll fraud is, the different types of fraud, and the steps your business can take to stop it.

What is payroll fraud?

Payroll fraud is theft from a business that occurs via its payroll processing system, usually by an employee or the employer.

Essentially, it involves falsification of payroll data in order for a person (the employee) or body (the company) to take money they aren’t entitled to. This can include standard wages, commission pay, or benefits.

The reason the fraudster is usually an employee or the employer is that it needs to be someone with knowledge of (and access to) a business’ payroll process. That said, some payroll fraud is also the result of third-party scams.

Types of Payroll Fraud

In order to prevent payroll fraud, it’s important to first understand what the different types of payroll fraud are. There are a variety of ways for employees and employers to cheat the system. Here’s are the most common:

1. Ghost employees

This is where employers are unknowingly paying employees that don’t exist. They can either be completely fake employees or ones who have left the company but are still on the payroll system.

For this type of fraud to occur someone needs to have created or kept a ‘ghost’ employee within your payroll processing system, and is transferring the wages, benefits and bonuses to themselves.

2. Buddy punching or timesheet fraud

This type of fraud is only perpetuated by employees. Timesheet fraud is one of the most common types of fraud and is commonly referred to as ‘buddy punching’ because it can sometimes involve an employee getting another member of staff to clock in on their behalf, even when they’re not there.

It can also involve simply falsely claiming to have worked a certain number of hours if the business doesn’t have a formal clocking-in system. Either way, the end result is the same: the employee receives wages for hours they haven’t worked.

Because of the nature of this type of fraud, it only occurs in businesses that pay their staff hourly, such as stores, restaurants, or warehouses.

3. Wage falsification

This type of payroll fraud is usually a double act, involving collusion between an employee and a member of your payroll staff. The employee gets paid more than they’re owed and then splits the cash with their payroll-based partner in crime.

What makes this one particularly hard to detect is that the offending member of payroll staff can later revert the employee’s wages back to normal, after they’ve received the inflated sum.

4. Commission fraud

This can refer to two types of fraud. The first is when an employee finds a loophole in the system to receive a commission or bonus that they didn’t earn. This type of commission fraud occurs most when a commission or bonus is tied to the employee completing a certain project or milestone. To commit fraud, the employee falsifies the results and claims the extra cash.

The second type of commission fraud is perpetrated by contractors the company has hired. Typically, they agree to provide the hiring companies with a certain number of workers to complete a job, but provide fewer workers than the promised amount, without telling the hiring company, and pocket the extra wages.

5. Employee misclassification

This type of fraud can be perpetrated by both employers and employees and involves misclassifying an employee in the payroll system so they are paid a different salary than they are owed.

When the employer is the perpetrator, this can involve classifying a full-time employee as a contractor or freelancer to reduce staffing costs and payroll taxes. When an employee is the perpetrator, the fraud usually involves them changing their status in the system to claim wages or benefits they aren’t entitled to.

What Are the Legal Consequences of Payroll Fraud?

Like with all crimes, the punishment for payroll fraud depends on the severity of the offence. A seasoned fraudster caught embezzling hundreds of thousands to millions of pounds across years of service will incur severe penalties.

This is valid for both employees and employers who commit payroll fraud, so it’s important to know how to prevent it.

The maximum sentence for false accounting in the UK is seven years in prison. Lower-scale offences attract fines of up to 150% of the fraudster’s weekly income, or community service work.

For example, in February 2024, a care worker in Dagenham was found guilty of timesheet fraud and ordered to pay £45,000.

How to Prevent Payroll Fraud: Top 5 Tips

From common sense to biometrics, we’ve outlined our top five tips to help you prevent payroll fraud at your business:

1. Check information carefully

The first rule for preventing payroll fraud is to know what it looks like – and that means being able to spot the signs. To do this, you’ll need to check all your payroll information thoroughly. That means wages, taxes, and personal details like names and bank account numbers.

Here’s what to look for:

• Employees with no deductions for taxes or national insurance
• Redundant employees who are still receiving pay
• Suspiciously large differences in pay between employees with the same title
• Multiple employees with the same personal details
• Unexplained changes in the payroll record, just as a change in an employee’s status or wage that’s not in line with an approved promotion or bonus

Any instances of duplicate payments, or repeated names or addresses, should set the alarm bells clanging. Likewise, payments to similar names (or variations on the same name – JO Bloggs, J O Bloggs, and J Bloggs, for example) should also be treated as suspicious.

Keeping a handle on all this information means you’ll be less susceptible to ghost employees, and the downright scary effects they can have on your profits.

2. Use a time and attendance system

If you pay your workers by the hour, installing a time and attendance system can go a long way in preventing timesheet fraud, or ‘buddy punching.’ The most secure systems are ones where employees need to use their own biometric data, such as thumbprint scanning or facial recognition to verify identity.

Not only does a time and attendance system work to eliminate the erosive effects of buddy punching on your business, but it also records breaks, punctuality, and annual leave, too – reducing your admin load while safeguarding you from payroll fraud.

Of course, not every business can afford these systems, so if you operate a system that requires a card, fob, or signature, make sure you or your managers check the time employees have logged against your own memory. If you have suspicions, having security cameras installed can quickly prove you right or wrong, since you’ll have footage to check.

3. Outsource your payroll services

Outsourcing payroll processing to a trusted and accredited third-party payroll services company can reduce the chance of fraud. When you outsource, the people who handle your employee’s payroll are less likely to have personal relationships with them, which decreases the incentives for fraud.

It also makes sense from a security perspective. By putting your payroll in the hands of a respected, reputable provider, you take it out of the hands of the small minority of your in-house staff that might choose to exploit it for themselves.

To learn more about the costs of outsourcing payroll, take a look at our guide. You can also find a list of trusted providers in our list of the top payroll service providers.

4. Segregate payroll duties

In small businesses, it can be easy to make one person (or team) responsible for running several functions. Just as the lines between sales, marketing, and advertising can become blurred, HR and payroll can also easily end up merging into a single entity.

Unfortunately, giving all the power to one employee increases the chances of payroll fraud.

It’s a good idea to:

• Keep your HR and payroll separate departments, run by different people. That way, any employee details being entered into the payroll system by your accountant will also need to be verified by someone from HR.
• Have payroll staff on a task rota, if you have a large team, so no one employee works on the part of the system permanently
• Ensure senior staff or management has complete oversight of the payroll process

This helps ensure that all of your payments go to the right place and narrows the window of opportunity for wage falsification.

5. Hire an auditor to monitor payments

Monitoring your payments regularly won’t just help you detect payroll fraud, it’ll also mean you can stop it from happening altogether. But even if you don’t have the time or patience to do this yourself, there’s no reason to let this slip – because you still have the option to hire an external auditor.

It’ll cost you in the short term, but the long-term benefits will pay for themselves.

Interested in reading more on pay policy? Find out whether salary transparency could boost your business by easing workplace tensions and improving recruitment.