Payroll fraud isn’t just a corporate buzzword. It’s a very real, very costly problem affecting businesses of all sizes. In fact, studies show that payroll fraud occurs in roughly 27% of all businesses, with small to mid-sized companies hit the hardest. And the kicker? These schemes often go undetected for more than two years.
But here’s the good news: payroll fraud is preventable.
This guide breaks down how payroll fraud happens, what red flags to watch for, and how U.S. businesses can protect themselves with the right tools, internal controls, and trusted partners like a Professional Employer Organization (PEO).
Payroll fraud is any scheme where someone intentionally manipulates a company’s payroll system for personal gain. While that may sound like something only large corporations deal with, the reality is quite the opposite.
Small businesses are more vulnerable because they often lack the proper internal checks and balances. One person might be handling payroll, bookkeeping, and employee onboarding—creating the perfect storm for mistakes or manipulation.
Common payroll fraud examples include:
Understanding how these schemes work is the first step to stopping them.
Payroll fraud can take many forms. Here are the most common types, how they operate, and why they often go unnoticed:
A ghost employee is someone who doesn’t actually work for the company but still collects a paycheck. This scheme is often carried out by someone in HR or payroll who creates fake employee records.
When employees clock in for coworkers who are running late or absent, it’s called buddy punching. Manual or outdated time-tracking systems are especially vulnerable.
Employees may log overtime hours they didn’t actually work, especially if managers don’t closely review timesheets.
Classifying full-time workers as independent contractors to reduce tax liability is not only unethical but illegal under IRS guidelines.
This occurs when employees submit fake or inflated expenses for reimbursement—like a personal meal labeled as a business lunch.
Payroll staff or managers might alter pay rates without approval, often benefiting themselves or others.
Sales or performance metrics can be falsified to inflate bonuses or commissions.
Sometimes employees request advances and never repay them, or they get paid twice due to system errors they don’t report.
Employees may report fake sick days to preserve vacation time or stretch long weekends.
Hackers or malicious insiders change direct deposit details so paychecks go into their accounts.
Most payroll fraud goes unnoticed because the signs are subtle. Here are key indicators:
Resistance to audits or questions about payroll data
Outsourcing payroll to a reputable PEO like Congruity HR adds a layer of protection that most small businesses simply can’t build in-house.
Benefits of using a PEO:
Why it matters: PEOs reduce risk, streamline payroll, and help ensure your workforce gets paid correctly—on time, every time.
Yes, employers can sue employees if they commit payroll fraud.
Ghost employees, buddy punching, and employee misclassification are among the most frequent.
Yes. Payroll fraud can result in criminal charges, including theft, wire fraud, and tax evasion.
Start with a confidential audit. Isolate the payroll data, check approvals, and involve HR/legal early.
Good software can flag anomalies, but human oversight is essential for context and judgment.
They use secure systems, follow strict controls, and bring in compliance professionals to manage payroll properly.
Payroll fraud is preventable—if you know what to look for and put the right systems in place. From tightening internal controls to working with trusted PEO partners, the key is to stay proactive.
If you’re concerned about payroll risk, Congruity HR can help you take control. Our secure, compliant payroll services are designed to protect your business and your team.
