Three Payroll Fraud Schemes

Businesses with fewer than 100 employees suffered from twice the rate of payroll fraud than larger businesses … that according to a study by the Association of Certified Fraud Examiners. As further fuel for the prevalence of payroll fraud, about 30 percent of businesses are victims every year.

 Businesses lose millions of dollars resulting from fraudulent schemes employees execute to take more money than they legitimately earned. Here we’ll take a look at the three most common ruses and how to take preventative steps to thwart the fraudsters.

  Ghost Employees

Simply put, a ghost employee is someone on the payroll who doesn’t actually work for the company. The ghost employee may be a fictitious person or a real person … frequently a friend or relative … working in concert with the charlatan to divert company funds for their own benefit.

Notably, ghost employees are reportedly the second most common type of payroll fraud … and your payroll staff or manager is too often the perpetrator.

Here are real-life cases of ghost employees “created” by trusted employees to bilk small businesses … with losses often exceeding 5 or even 6 figures.

·         Hank seemed to be a reliable employee with the best interests of the company at heart. Hank also recruited a phantom employee group who worked at other companies. As hiring manager, Hank completed time sheets, authorized payment and split the winnings with his co-conspirators.

·        Ellen Marie Taylor, your payroll clerk, concludes that she is worth more than she’s being paid. Solution: Multiply her compensation by either creating a new employee (Phyllis Jones) or maintaining someone on the payroll who has left the company. In either case, Ellen Marie will divert the funds to Phyllis Jones and cash the check.

 Falsifying Compensation

This form of fraud involves compensating employees for work not performed or at rates that are not consistent with the agreed-to compensation package. For example, a supervisor and employee may enter into a conspiracy of collusion to over-report the worker’s hours or raise the employee’s pay and then split the falsified excess compensation.

A variation on this scam involves those compensated on commission. Commissions or performance bonuses may be overstated with a similar scenario to that described above. Likewise, bogus expense accounts may be a vehicle to generate illicit cash.

A real-life scenario is the office manager responsible for payroll who quit. On the way out the door, she gave herself a bonus and reimbursement for unused vacation time. Discovery was several months later … when she was long gone with no practical recourse for the employer.

 

Non-Payment of Payroll Taxes

Non-payment of payroll taxes is an issue that is not negotiable with the Internal Revenue Service. Regardless of the perpetrator, the employer is responsible for all unpaid payroll taxes plus penalties … which can be significant including fines and possible criminal charges.

A business owner may engineer diversion of payroll taxes for other purposes … either personal gain or to augment company cash flow shortfalls. Alternatively, it may be a culprit in the accounting department who decides the funds will be more satisfactorily employed by him or her rather than a remittance to Washington.

Another version of employer initiated payroll fraud with the same downside penalties is worker misclassification with the intent to avoid paying payroll taxes and benefits plans. The IRS requires employers to classify workers as either independent contractors (compensation reported on form 1099) or W-2 employees. Recently, the Department of Labor has chimed in with an interpretation as well.

Bottom-line for small business owners: Be aware of intensified scrutiny by the feds and if you are tempted to “split hairs” in a worker classification … seek help from your tax advisor.

As examples closer to home, three David H. Creasy, CPA clients had similar disastrous experiences. Responsible company officersreviewed and signed the quarterly payroll tax forms 941 and gave to bookkeepers to mail. Each bookkeeper placed the signed forms 941 in a drawer or destroyed them.

Once David Creasy identified that tax deposits weren’t being made, the real trouble started with the IRS and expenses for lawyers and accountants. Settlements ranged from all back taxes paid plus penalties to a waiver of penalties and a payment plan to reimburse taxes.

Fortunately, none of these businesses had to close their doors, but they were just lucky.

The answer is to make sure all payroll tax deposits are actually being made … in full and on time. Remember, the employer is ultimately liable for withheld payroll taxes – no excuses accepted.

The Employee Theft Trigger

The widely accepted theory among fraud prevention experts pinpoints the trigger as something rather subtle – opportunity – prompted by motivation and justified by rationalization.

Motivation

The range of financial motivators may be as diverse as heavy health care expenditures, gambling debts, substance abuse or just a desire to live a bit “higher on the hog.”

Opportunity

The Opportunity represents a perceived ability to successfully carry out the fraud.

Rationalization

This is where the employee consciously justifies the intended action. “After all I’ve done for this company, I have it coming.” “I deserved that promotion and didn’t get it.” And so forth.

Eliminate any one of these three elements and there will be no crime.