How to Prevent Payroll Fraud & Secure Your Systems

What is Payroll Fraud?

Payroll fraud happens when an employee or employer inside the company exploits the payroll system to pocket money they're not entitled to. It typically involves tactics like adding ghost employees, inflating hours, sneaking in unauthorized bonuses, or tampering with salary rates. Though these tactics may seem small individually, they can have a big impact financially without raising immediate suspicion.

It’s also interesting to note that even accidental payroll errors can have legal implications for organizations. Consider this case involving the US government, for example: A few years ago, in 2016, the Pentagon found itself in hot water over a payroll error where thousands of California National Guard members were given re-enlistment bonuses they didn’t qualify for. The soldiers didn’t know they were ineligible, but the government still demanded they pay back up to $40,000, with interest! It caused a huge backlash, but the truth is, employers, whether public or private, can legally recover overpaid wages if they can prove it was a mistake.

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An honest payroll mistake usually has less severe consequences, such as corrective actions or lower penalties, and it’s usually dealt with on an internal level. In contrast, payroll fraud is committed with intent, and can have dire consequences, including criminal prosecution, fines, litigation, and likely will lead to considerable reputational damage.

Amy Smith, Legal Counsel at Playroll

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On average, each incident of payroll fraud costs a business around $65,300, and it can take 18 to 30 months to detect. With nearly 10% of all occupational fraud reported falling under the payroll umbrella, it’s a serious risk for any organization handling global salaries and benefits.

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10 Types of Payroll Fraud & How to Prevent Them

Payroll fraud schemes come in many forms, some obvious and simple and others more subtle and highly sophisticated. Let’s unpack each type, plus the  actionable steps you can take to tackle them.

1. Ghost Employees

Ghost employee payroll fraud is chillingly simple and surprisingly common. It occurs when someone inside HR or payroll adds a fictional worker, a deceased person, or even a relative into the payroll system. No forged IDs or fake attendance sheets needed: they create the name in the system, schedule pay, and channel the funds into an account they control.

Because everything looks clean on paper, this type of fraud often goes unnoticed. Week by week, month by month, those ghost payments quietly pile up, draining payroll budgets without raising alarms. These payroll fraud schemes fly under the radar because each payment looks just like any other. Audits may show the right number of employees, budget projections may match, and HR may even confirm the ghost as a “team member.”

How to Prevent Ghost Employees Fraud

• Require dual approval for adding new hires
• Reconcile headcount regularly
• Automate alerts for duplicate SSNs/bank accounts
• Engage external auditors periodically

Real-Life Example

Nowhere is this type of payroll fraud more evident than the recent case in Ghana, where over 81,000 ghost names were discovered on the National Service Authority’s payroll, leading to around ₵226 million (US $14.6 million) being paid out in alleged ghost salaries

2. Falsified Hours

Ever heard of “padding the clock”? That’s what timesheet fraud is all about. It happens when employees claim they worked more hours than they actually did, maybe by clocking in early, clocking out late, or even having a colleague punch in for them. In industries with lenient time tracking or manual timesheets, it’s shockingly easy such as retail, construction, healthcare, and hospitality.

The result? Everyone’s paycheck looks legitimate, but the company ends up paying for hours that weren’t worked. Sometimes these go unnoticed until a detailed audit reveals patterns of consistent “extra” time

How to Prevent Falsified Hours Fraud

• Use biometric attendance systems
• Enforce cross-departmental approval of timesheets
• Flag extreme time entries via analytics
• Spot-check timesheets against project logs

Real-Life Example

An Long Island Rail Road (LIRR) inspector in New York falsely claimed hundreds of overtime hours (10 hours daily) in 2018, making him the highest-paid Metropolitan Transportation Authority (MTA) employee, earning an extra $344,000 in fraudulent pay before being convicted.

3. Sick Leave Fraud

Imagine someone taking “sick leave” to relax at the beach while claiming they’re too ill to work, and getting paid for it. That’s sick-leave fraud. It happens either through faked or altered doctor’s notes or by subtly bending the truth to cover days off.

Surveillance footage from a gas station in the Netherlands exposed one such case where an employee claimed to be bedridden but was spotted working at a restaurant. That kind of blatant misuse not only drains payroll but also undermines workplace trust.

How to Prevent Sick Leave Fraud

• Require documentation for extended sick leave
• Benchmark leave usage within departments
• Use HR systems to flag repeated patterns
• Review spikes in sick leave around weekends or holidays

4. False Expense Reimbursement

Expense reimbursement fraud is like a mini‑heist hidden in plain sight. It happens when employees submit fake or inflated business expenses. This could be anything from rounding up a meal, reusing the same receipt, or passing off personal purchases as work-related. They might doctor receipts, duplicate submissions, or claim expenses that never happened.

This type of fraud is stealthy and widespread, accounting for about 13% of all asset misappropriation cases and often slipping past detection for 18 months or more, with a median loss around $33,000 annually.  

How to Prevent Falsified Expenses Fraud

• Require digital receipt uploads
• Use systems that flag duplicate claims
• Perform monthly expense audits
• Validate claims against travel or project data

5. Workers’ Compensation Fraud

Workers’ compensation fraud happens when employees fake or exaggerate injuries, or claim they’re still recovering when they’re perfectly healthy. Some even work another job at the same time, or use fake medical documents to keep the checks coming.

These cases are often subtle until someone digs into the details. Premium fraud can cost insurers and employers dearly, and inflating compensation payouts can also trigger serious legal penalties.

How to Prevent Workers Compensation Fraud

• Integrate HR and compensation systems
• Use independent medical reviews
• Cross-check leave and medical records
• Monitor repeat and inconsistent claims

6. Employee Misclassification in Tax-Lax Jurisdictions

Misclassification fraud occurs when companies label full-time workers as independent contractors, often to avoid paying payroll taxes, insurance, or benefits. It’s a way of cutting expenses at the cost of compliance.

This may appear harmless initially, but misclassification exposes employers to steep fines, sometimes up to $25,000 per worker, plus back taxes and interest. It’s a hidden risk that snowballs fast when regulations catch up.

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Avoid misclassification risk with our step-by-step guide.

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How to Prevent Employee Misclassification

• Use compliant contracts and pay templates
• Employ classification tools during onboarding
• Conduct biannual classification audits
• Convert contractors to full-time employment if needed

7. Commission Fraud in Sales-Driven Markets

Think of commission fraud as gaming the sales leaderboard. Employees might inflate their numbers, invent phantom deals, or manipulate commission or bonus percentages to pad their checks. When CRM systems aren't directly linked to payroll, these inflated numbers slip through unchecked.

This type of fraud is common in retail and sales industries because it’s easy to hide in the noise of real sale – that is until inflated payouts start looking out of sync with actual performance, which often only shows up during quarterly reviews or CRM reconciliations.

How to Prevent Commission Fraud

• Use CRM-to-payroll automated syncing
• Match commission to actual collateral/sales
• Maintain audit logs for rate changes
• Conduct periodic audits on commissions or bonuses

8. Buddy Punching

“Buddy punching” is when employees clock in or out for each other. It starts as a friendly favor, but quickly becomes a hidden expense if left unchecked. In paper-based or shared-credentials systems, these fake punches accrue into real labor costs.

It’s surprisingly widespread: 75% of companies report elevated time theft due to buddy punching. In small teams, even a few regular cheats can cost tens of thousands annually.

How to Prevent Buddy Punching

• Use biometric or geofenced clock-in systems
• Require manager sign-off on timecards
• Spot-check logs vs. schedules
• Rotate supervisors to prevent collusion

9. Pay Rate Manipulation

This scam happens when someone changes an employee's hourly or salary rate without approval, sometimes for themselves, sometimes for an accomplice. It might involve off-cycle raises, manual overrides, or “forgotten” approvals.

Because midcycle or ad hoc changes don’t always trigger alerts, these fraudulent bumps can slip through until someone notices payroll outpacing budget trends or unapproved escalations in paychecks.

How to Prevent Rate Pay Manipulation

• Enforce multi-level approval for rate changes
• Notify employees of any changes
• Monitor audit logs weekly
• Restrict payroll access and privilege levels

10. Unauthorized Deductions or Diversions

The final form of payroll fraud, unauthorized deductions or diversions, is particularly devastating. This happens when someone changes an employee’s direct deposit information or deduction settings without them knowing, so their money goes elsewhere. It usually begins with phishing, hacked credentials, or insider access.

Employees think they’ve been paid, but the funds never hit their bank. These stealth diversions quietly drain trust and revenues, and can go undetected unless banking data is cross-checked regularly or impacted employees raise the alarm themselves.

How to Prevent Unauthorized

• Require validation for edits to bank details
• Automate employee notifications of changes
• Monitor deduction vs. pay trends
• Log all ACH/routing edits with timestamp

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How Payroll Fraud Happens

Payroll fraud isn’t always someone sneaking a paper check, it can be highly sophisticated, carried out both from the inside and outside the organization.

• Collusion: A scheme where two or more employees (often in HR, payroll, or management) work together to manipulate payroll records. For example, an employee might create a ghost payroll record while another approves it. By working together and verifying each other’s false entries, they make fake data appear real, which sharply reduces the chances of any red flags being raised by audits or spot checks.
• Unauthorized Access: Cybercriminals or insiders that see an opportunity to exploit weak payroll security systems (stolen credentials, poor network protection, or lack of monitoring) to gain access to company payroll systems. They may redirect funds, create fake entries, or extract sensitive data such as Social Security numbers .
• Technology Misuse: As companies adopt AI, scripts, and ERP integrations, fraudsters can use these tools to create payroll automation-driven schemes. A fraudster could for example, generate ghost workers monthly or override pay rates en masse. These advanced methods are often complex enough to bypass basic control systems.

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Signs and Detection Methods

Catching payroll fraud early can save your company thousands in losses and headaches down the line.

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During payroll, data moves across different systems and stakeholders internally and externally – there are all these points in the process where there is potential for data manipulation. Data validations between those different sources helps make sure that none of that is happening or that you have visibility when it does happen.

David Avshalom, VP of Product Strategy and Operations at Playroll

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Key Red Flags Include:

• Unexplained discrepancies in payroll records: Watch out for sudden spikes in pay, missing deductions, or adjustments without explanation. These can indicate manipulated entries.
• Unusual payment patterns: Look for mid-cycle lump-sum payouts, repetitive manual corrections, or increases in overtime without clear reasoning.
• Inconsistent employee data: Duplicate Social Security numbers, address mismatches, or multiple bank accounts for the same person are all big warning signs.

Detection Methods

• Regular Payroll Audit: Scheduled monthly or quarterly payroll audits or reviews can proactively uncover ghost access to the payroll system, unexplained payroll changes, or unauthorized deductions.

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How to Prevent Payroll Fraud

Prevention is always better than cure. It’s better to be proactive than wait around for something to go wrong, particularly if you are outsourcing your payroll functions to a third-party.

1. Strong Internal Controls

First up: strong internal controls. One person should never own the entire payroll process. Instead, separate the responsibilities so one team inputs data, another reviews it, and a third approves it. Approval workflows also bolster security by requiring multiple sign-offs on new hires, timesheet edits, or pay raises. This layered approach reflects modern Committee of Sponsoring Organizations of the Treadway Commission (COSO) best practices, making fraud much harder to pull off unnoticed.

2. Payroll Software

Next, robust global payroll software can act as your first line of defence. For example, Playroll’s platform flags suspicious entries automatically, whether duplicated SSNs, out-of-cycle pay spikes, or unusual time entries. Every action is logged in a secure audit trail and routed through enforced approval gateways.

With these built-in safeguards, ghost employees or secretive rate changes become nearly impossible to slip through undetected .

3. Employee Training

Systems alone aren’t enough to mitigate the risks of human error. Training and awareness are important as well. Regular workshops teach staff to spot warning signs such as: expired medical notes for sick leave, oddly repetitive expense claims, or sudden direct-deposit change. They also encourage anonymous reporting. Employee vigilance is a powerful early warning sign.

4. Cybersecurity Measures

On the cybersecurity front, protecting payroll data is non-negotiable. Your system should encrypt sensitive data, enforce multi‑factor authentication, and restrict access through role-based permissions. Admin credentials must be rotated regularly, and login attempts monitored in real-time. These features match best-practice cybersecurity protocols to fend off attacks and insider threats

5. Regular Audits

Both external and internal routine audits are payroll's best friend. Think of them as regular health checkups for your payroll processes. Instead of waiting for a problem, we recommend scheduling monthly or quarterly reviews that blend automatic scans with human oversight. These reviews often highlight abnormalities that automated systems can miss, like payments made to terminated employees or unexplained shifts in overtime.

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It’s not feasible for a business to see everything all the time, but you should have the ability to trace an audit trail like bread crumbs that you can go back to. What took place when and by whom? We systematically add that audit trail layer of multilayer approval, so there is aggregation of duty, access controls, and permissions.

David Avshalom, VP of Product Strategy and Operations at Playroll

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6. Change Notifications

Finally, change notifications act as an early alert system. Every pay raise, banking update, or status change should trigger an automatic notification sent to the relevant employee and HR admin. For high-impact changes, 2FA verification can add another layer of defense.

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Legal and Compliance Risks of Payroll Fraud

Besides losing you money, payroll fraud risks legal trouble that can follow your business for years. Imagine misclassifying contractors as employees. For example, in the U.S., if the IRS flags it, you could face fines starting at $50 per missing W-2, plus 1.5% of total wages, 40% of unpaid employee FICA, and even 100% of the employer’s FICA share, with added interest and penalties.

These penalties could be as high as 25% of the unpaid amount. That’s before considering intentional misconduct, which can bring criminal fines up to $1,000 per worker and even jail time.

The fallout doesn’t stop there. Companies found guilty of misclassification or payroll fraud often get hit with wage-and-hour lawsuits under the Fair Labor Standards Act. That means back pay, overtime calculations, liquidated damages, and attorney fees, all of this on top of rebuilding shaken trust across teams. Payroll fraud also erodes reputation with regulators, investors, and "rightful employees" who may feel betrayed.

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Impact of Remote Work on Payroll Fraud

Working remotely or in a hybrid setup is convenient, but the flexibility and lack of in-office accountability means it also opens the door to sneakier types of payroll fraud. Without the usual in-office supervision, things like unsupervised clock-ins, “buddy-punching,” phishing scams, and stolen credentials become a lot more common. That’s why your organization needs a secure, cloud-based solution, like Playroll.

Playroll's system keeps things honest by syncing data in real-time across locations, meaning there’s no manual CSV upload that someone could tweak. With secure API and HRIS integrations, data flows directly between systems instead of being copied and pasted, reducing opportunities for manual errors and tampering. All your systems are kept updated in real-time – instantly identify payroll mismatches with real-time variance alerts.

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Mitigate the Risk of Payroll Fraud With Playroll

Payroll fraud is a ticking time bomb that affects every corner of your business. From hidden ghost employees to inflated hours, and fake deductions to misclassification, these schemes can silently drain resources, erode trust, and expose you to serious legal consequences.

The good news: a comprehensive, layered approach can head off opportunities for fraud. At Playroll, we’ve built these strategies into our platform so fraud risks are caught early, not retroactively.

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By partnering with a reputable provider that specializes in the payroll field, you create a separation between those authorising the employee payment and those actually processing it. This will allow for reduced internal risk, specialist management, and oversight of the payroll process, ultimately improving compliance.

Amy Smith, Legal Counsel at Playroll

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While payroll fraud might look like a small inconsistency today, it could become tomorrow’s headline. With proactive planning, ongoing vigilance, and expert support, payroll integrity becomes one less thing to worry about. Book a chat with our experts to learn how we can protect your business with payroll solutions that seamlessly integrate into your systems.