Payroll fraud rarely stares you in the face. Instead, it lurks in the shadows of your workforce systems — in overlooked approvals, outdated payroll processes, and assumptions that everything’s working as it should. One wrong work rate here, an unchecked name there, and suddenly you’re paying for work that never happened.
This kind of fraud often goes unnoticed until something shines a light on it: an audit, a whistleblower, or a mounting line item no one can explain. And by the time it’s visible, your organization is already out time, money, and trust you can’t get back.
This guide breaks down what payroll fraud looks like, where it tends to hide, what real-world cases reveal, and how to prevent it from gaining ground in the first place.
What is payroll fraud?
Payroll fraud is any intentional manipulation of your payroll system to provide unearned pay, benefits, or reimbursements to someone who didn’t earn them.
It can come from insiders with system access, or contractors and vendors who take advantage of weak oversight. Payroll fraud is dangerous because it often hides in your daily tasks: logging hours, cutting checks, and managing PTO.
Unlike general financial fraud, payroll fraud goes beyond your bottom line to affect your people. Pay is personal, and mistakes (accidental or not) quickly lead to confusion, burnout, or worse, a lawsuit.
Unfortunately, it happens more than most teams realize. A lack of internal controls, outdated payroll processes, or blurred roles between HR and finance make fraud easier to happen and harder to detect.
Common types of payroll fraud
No one wants to think fraud to their organization — the most notable fraud cases happen in news headlines, not to us, right? But the truth is, fraud often starts small and hides in plain sight:
- A few extra hours here
- A missed audit there
- A raise that wasn’t properly reviewed
Most payroll fraud doesn’t begin as a massive scheme. It slips through everyday processes and goes unchecked for too long. Payroll fraud takes many forms, depending on how your team handles employee scheduling, payroll processing, time tracking, and leave approvals.
With busy teams, outdated systems, or unclear responsibilities, the door opens for both honest mistakes and intentional manipulation. Knowing how payroll fraud can show up is the first step to stopping it.
These are the most common methods bad actors use to exploit gaps in the process:
Falsified hours and timesheets
When employees log their time manually or use outdated time tracking systems, it’s easier to overreport hours. Some of this comes from “buddy punching,” when one employee clocks in or out for another. Other times, employees simply inflate their hours or add overtime that wasn’t worked.
All these methods, whether deliberate or accidental, fall under the broader category of time theft. But for purpose use of this article, we’ll reference each action separately.
In retail and manufacturing, where shift-based work is common, this kind of fraud can add thousands in extra payroll costs if left unchecked.
Common examples:
- Clocking in early and leaving late without supervisor verification
- Repeatedly logging overtime without approval
- Retroactive edits to timesheets without audit logs
Ghost employees
A ghost employee exists in your payroll system but doesn’t actually work for your company. These fake entries are often created by someone in HR or payroll who has access to add new employees, assign direct deposit info, and authorize payments.
This type of fraud can fly under the radar in fast-growing companies or organizations with high turnover, like construction and hospitality. If no one double-checks employee rosters against schedules or time records, fraudulent pay can go unnoticed for months.
Watch out for:
- Employees on payroll with no matching time or schedule data
- Duplicate bank account numbers across employees
- Paychecks continuing after a documented termination
Misclassifying employees as independent contractors
Employee classification has major implications for taxes, benefits, and overtime. When a worker is misclassified as an independent contractor, your organization may avoid payroll taxes or benefit obligations but at serious legal risk.
This mistake happens in various industries but is especially risky in construction, healthcare, and logistics where contract labor is common. The IRS and the Department of Labor enforce strict standards for determining worker status.
Key risks include:
- Back payment of taxes, overtime, and benefits
- Fines for wage law violations
- Lawsuits from misclassified workers
Unauthorized salary increases or bonuses
When too few people control payroll data, it becomes easier for someone to adjust their own compensation. This could mean issuing a “bonus” without approval, inflating base pay in the system, or changing pay rates quietly over time.
This form of fraud depends on weak role permissions and slight separation between data entry, approval, and processing.
Warning signs:
- Raises or bonuses issued outside of typical review cycles
- Inconsistent records across HR and payroll systems
- Lack of documented approval trails
Expense reimbursement fraud
If your payroll system also handles reimbursements, there’s an opportunity for employees to slip in fraudulent expenses. These could be exaggerated, repurposed, or completely falsified old receipts.
Without receipt matching, review thresholds, or required notes for submission, these can easily pass through.
Examples include:
- Duplicate submissions
- Personal meals or mileage claimed as business
- Reimbursements processed for canceled events or trips
PTO padding and unearned accruals
Some employees may manipulate leave balances to cash out more PTO than they’ve earned. This can happen through system errors, backdated entries, or requesting leave payouts after termination without updated accrual records.
In industries with large hourly workforces — like hospitality and healthcare — tracking PTO balances in real time helps prevent this type of manipulation.
What payroll fraud really costs you
Payroll fraud creates hidden liabilities far beyond line items lost to bad luck. If it’s not caught, it can quietly drain hundreds of thousands of dollars from your organization while damaging employee trust, regulatory compliance, and operational integrity.
This isn’t inflating or overstating payroll fraud’s damage. Check out the real-world payroll fraud cases that reveal just how easily it starts and what it costs when no one’s watching.
- The Los Angeles Unified School District discovered that a former employee received $500,000 in paychecks over six years due to a system error and lack of reconciliation after their termination.
- Former City of Atlanta attorney fraudulently obtained $15 million in funds by inflating payroll numbers and fabricating employee data across four businesses. The scheme went undetected until federal investigators flagged the discrepancies.
- A Pennsylvania nursing home administrator created ghost employees and collected $100,000 in fraudulent wages. The fraud continued until a routine external audit flagged it.
- An HVAC contractor in Texas misclassified workers as 1099 contractors to avoid paying overtime and benefits. The Department of Labor found the violation during a wage audit and assessed over $350,000 in penalties and back wages.
In each case, fraud happened because of too much access in too few hands, a lack of checks and balances, and no consistent audit trail. If you don’t know exactly who’s approving time, bonuses, or employment status changes, payroll fraud risks could already be costing your organization more than you realize.
What are the risks of payroll fraud?
The initial financial loss is just the first and most apparent consequence of payroll fraud. But in the long term, the effects ripple throughout your organization from compliance violations to employee churn. When payroll systems are vulnerable, your risk goes from monetary to reputational, operational, and legal.
Let’s take a closer look at what’s really at stake.
Financial loss
The Association of Certified Fraud Examiners (ACFE) reports that payroll fraud costs organizations a median of $65,000 per case, with many going undetected for over a year. That number doesn’t include payroll re-processing time, conducting internal investigations, or correcting financial reporting.
In construction and field services, where job costing is tightly linked to payroll, these discrepancies can throw off bids and forecasting, making financial planning less accurate and more vulnerable to error.
In high-turnover industries like retail and hospitality, repeated payroll losses create budget bloat that’s difficult to trace back to a single source. And even if your company has insurance to cover fraud, the time lost to audits, corrections, and internal cleanup is rarely recoverable.
Legal and compliance exposure
Payroll fraud most often overlaps with legal risk. When your employees are underpaid, misclassified, or compensated in ways that violate wage laws, your organization becomes exposed to audits, lawsuits, and government fines.
Federal laws like the Fair Labor Standards Act (FLSA) mandate accurate timekeeping and proper classification of exempt vs. nonexempt workers. The IRS enforces strict penalties for misclassifying employees as contractors. States may require detailed pay stubs, timely final paychecks, and meal or break tracking — all of which can be compromised by payroll fraud.
Hospitality and healthcare employers often face added risk due to complex schedules, shift differentials, or inconsistently tracked mandatory overtime. A small pattern of errors can easily turn into a Department of Labor investigation or a wage theft claim.
Penalties may include:
- Repayment of unpaid wages or taxes
- Fines from federal or state labor agencies
- Attorney’s fees and settlement costs if a lawsuit is filed
Damaged reputation and employee trust
If your employees can’t trust that they’re being paid correctly, they’re less likely to stay. Even small mistakes create anxiety, especially when they happen repeatedly.
Employees may publicly discuss payroll issues, file formal complaints, or leave. That churn costs time, money, and morale, especially in retail or manufacturing industries where retaining experienced shift workers is already a challenge.
It takes time to build a reputation as a dependable employer, and just one serious payroll misstep to lose it.
How to prevent payroll fraud in your organization
You don’t need to scrutinize every pay run to catch fraud. The key is to build smarter systems that reduce opportunities and make detection easier. By creating clear roles, automating where it counts, and increasing visibility across departments, your payroll process becomes both safer and more efficient.
Let’s break down some core strategies:
Strengthen internal controls
Fraud often occurs when control is overly concentrated to one person. If a single person can initiate, approve, and process payroll changes, there’s little to stop misuse or mistakes.
A more secure setup separates responsibilities between HR, payroll, and finance teams. Set up required approvals for salary changes or new hires, and reconcile time and pay data each month to keep things in check.
Use secure, automated systems
Manual entry opens the door to fraud, whether intentional or not. Automated systems help close those gaps by enforcing user permissions, tracking all changes, and catching inconsistencies early.
Look for platforms that sync payroll with time tracking in real time, prevent unauthorized retroactive changes, and flag suspicious activity, like two employees using the same bank account or duplicate Social Security numbers.
Monitor for suspicious patterns
Fraud is more often overlooked than it is intentionally sophisticated. Routine checks can catch common red flags, especially in areas like overtime, bonuses, or off-cycle adjustments.
Set up reports or alerts for frequent timecard edits, unexpected rate changes, or multiple employees tied to one deposit account. Even a monthly review can surface patterns worth investigating.
Train your team to recognize red flags
People can’t report what they don’t recognize. Give your HR and payroll teams the tools and confidence to spot fraud early and act on it immediately, such as:
- Schedule training sessions with practical examples and compliance refreshers
- Create opportunities for cross-functional reviews
- Offer anonymous ways for employees to report concerns without fear of retaliation
Payroll fraud prevention checklist
Here’s a quick-reference checklist to help you reduce risk and reinforce accountability across your payroll process:
| Action | Why it matters |
| Separate roles | Reduces risk by dividing data entry, approval, and processing |
| Enforce multi-step approvals | Adds checks for salary changes, new hires, and direct deposits |
| Reconcile payroll and time data | Helps catch discrepancies before they escalate |
| Use secure, automated software | Protects data and enforces permissions automatically |
| Flag suspicious activity | Identifies duplicate accounts, excessive edits, or irregular pay |
| Train staff quarterly | Keeps fraud awareness fresh and improves internal collaboration |
| Enable anonymous reporting | Encourages employees to speak up when something feels off |
These actions work together to create a payroll system that’s not just compliant, but resilient.
Why prevention pays off
Payroll fraud doesn’t always come with flashing lights, but the fallout can hit hard. From backpay and penalties to lost trust and public exposure, the hit on your payroll line is the least of your concerns.
Audit checkboxes only go so far. Real prevention is a strategic commitment to accuracy, accountability, and long-term team health. With the right tools and internal practices, you won’t need to over-monitor or micromanage to create an anti-fraud process.
Payroll management software can support you by creating a clear record of who worked, what they earned, and how it was approved, without relying on memory or manual processes. The more visibility you build into your payroll process, the less likely fraud is to take root.
And when your team knows their pay is accurate and protected, everything else runs a little smoother.
TCP Software’s employee scheduling and time and attendance solutions have the flexibility and scalability to suit your business and your employees, now and as you grow.
From TimeClock Plus, which automates even the most complex payroll calculations and leave management requests, to Humanity Schedule for dynamic employee scheduling that saves you time and money, we have everything you need to meet your organization’s needs, no matter how unique. Plus, with Aladtec, we offer 24/7 public safety scheduling solutions for your hometown heroes.
Ready to learn how TCP Software takes the pain out of employee scheduling and time tracking? Speak with an expert today.
