Running a payroll can be tricky enough even if you have a full team of honest employees and vendors. As soon as there is active fraud in play, it can be financially and emotionally stressful. In order to best defend your payroll process and company from harm, it’s important to know the legal payroll fraud definitions and what you can do to safeguard against it.
That’s why we’ve put together this handy guide of what to look for in the world of payroll security along with some proactive and reactive measures. We’re betting that you’ll come away feeling much better about the security of your small business payroll once you’d have a look at this information.
What Are the Common Mistakes that Happen During the Payroll Process?
While we typically view payroll fraud as a malicious act perpetrated by one or several people, it is also very difficult to accomplish without internal error allowing it to continue. If you are running in-house payroll or having a third-party processor, you should make sure to look out for the following red flags:
- Not Having Secure Financial Information: This can range from w-9 forms, new-hire packets, social security information, or the actual payroll data itself. For any sensitive information, it needs to be password protected with a select group of individuals who have this password. It should be stored securely, and changed often. Additionally, always make sure to shred and dispose of any physical documents containing sensitive information.
- Not Having Multiple-Party Oversight: Payroll is difficult and tedious, which often leaves business owners and executives to delegate or outsource it. No matter what size business you have, it is still vital to make sure that your accounting department or third-party payroll processor is being audited by someone not associated with that unit. Ultimately, if one person or team is in charge, they can be susceptible to multiple types of payroll fraud. A simple check-in or audit periodically can save you a lot of money and headaches.
- Not Following Through on Canceled Checks: Even in an honest payroll system, errors are bound to occur. This will often lead to check adjustments, and you may have to write some manual checks. This can already cause problems even if no one is looking to take advantage of the system, but if there is an employee who can see the monetary amount of checks that were processed, not canceled, but not cashed, they can extract this amount without being caught easily. Thus, any time there is a mistake that alters the status of a check, make sure to have it documented and followed up on.
- Not Planning for Change in Payroll Protocol: Unless your business has a few employees, no physical job site, or labor is a small part of your product, the chances are that you will go through turnover, expansion, and changes in the payroll process. One of the biggest mistakes we see is a company not thinking through their next steps as they adopt contractors, different departments, or job sites to an already existent routine. This opens the door for on-the-fly decisions to be made that can expose your information and let malicious fraud occur if you’re not careful.
There are all sorts of payroll errors that lead to millions of dollars of loss each year. Over 57 percent of small businesses suffer from some sort of material loss from incorrect information. However, this number is greatly reduced if you alleviate mistakes that open the door to fraud.
How is Payroll Fraud Detected?
Payroll fraud can be committed intentionally or on accident, and by both employees or employers. With so many different ways to compromise your payroll, how can you be sure that your data and money are safe? The answer is to create broad protocols that allow you to find as many behavioral and statistical outliers as possible. We recommend the following methods:
- Random third-party audits of payroll records: This should be done by someone who has no connection to the normal payroll process. It can be an owner, executive, or even someone outside the company.
- Budget for payroll and back-test: Your scheduler should have a rough estimate of hours that are needed during each pay period. Additionally, they should be noting any changes. If you actually project what these costs are to the dollar (which many teams do not), you will notice extreme discrepancies.
- Create a verification protocol: If you work at a physical workspace, create a periodic meeting such as monthly or quarterly that requires a sign-in sheet for verification. If you work remotely or have multiple job sites, either host a video call with a roll-call, or make sure that you have someone contacting all active members of your team and asking for a specific response.
Once you have detected it, there are a number of ways that payroll fraud should be reported. Depending on who is committing it (whether it is an entity level, single person, or combined effort), the most prudent way may be reporting to the state. This is especially true for worker’s comp fraud, as you want to avoid the legal pitfalls of going after a fraudulent employee without the law on your side.
How to Protect Against Payroll Fraud
Now that we have detailed payroll processing errors and detection tactics, let’s go over some quick tips about how to protect payroll fraud from affecting your bottom line:
- On-site Security Cameras: These help with verifying hours, clock-in times, and preventing worker’s compensation fraud. As there are many remote-access time clocks, it is easy to commit time theft if there are not geo-fenced clock-ins or cameras.
- Limit access to Payroll Data: While you need to have multiple sets of eyes on your payroll process for audits and verification, too many employees with access will cause problems. One of the easiest ways for payroll fraud to occur is for an employee to notice patterns or inputs that might not be secure and open for exploitation in your process.
- Review Payroll Reports at the Executive Level: Unsurprisingly, wage theft and payroll fraud hurt small businesses the most. If you have an owner or executive willing to commit some of their time to review payroll, it should prove extremely effective, as they will have the most oversight and intimate knowledge of the entire business.
- Segregate Payroll Duties: This is another form of multiple-party oversight; if you make it so that payroll cannot be run without two or more people creating a report that is audited, it will be very hard to run fraudulent payroll consistently.
- Check Social Security Numbers with National Databases: This is mostly to prevent ghost employees. Ghost employees are when someone who has access to payroll distribution will set up a fake employee (though often using real information) in order to funnel money. This is one of the most common and detrimental forms of payroll fraud.
Ultimately payroll fraud prevention is about optimizing your systems for efficiency while not narrowing them down to just one person or team. It is a balancing act, but one that can be made much easier with reputable third-party payroll processing systems or frequent outside audits.
Contact PayTech to Help Prevent Payroll Fraud
At PayTech, we have decades of experience in helping businesses of all sizes optimize their payroll process. This includes running it, helping set up defense mechanisms, or educating your high-level employees in charge of it. If you believe your business could benefit from an upgrade in payroll system, it might be time to get the help you need.
The bottom line is we care about yours, so don’t hesitate to reach out for a free consultation – we’d love to help.