At Risk For Payroll Fraud? 7 Steps to Protect Your Small Business

Hey there, fellow business owner! Let’s be real for a second—running a small business is tough enough without having to worry about something like payroll fraud. But the reality is, payroll fraud is one of the most common ways businesses, especially smaller ones, lose money. According to the  ACFE Report to the Nations 2022, payroll fraud happens in 27% of all businesses, and small businesses are twice as likely to experience it compared to larger companies.

The good news? It’s preventable! And today, we’re going to dive into exactly how you can protect your business without losing sleep.

So, let’s chat about some key steps to keep your business safe and sound from payroll fraud. Think of this as one friend sharing some tips with another over coffee.

What Exactly Is Payroll Fraud, and Why Should You Care?

Okay, before we dive into the "how," let's make sure we're clear on the "what." Payroll fraud is when someone (yes, even someone on your team) manipulates the payroll system to steal from your business. This could mean padding hours, issuing fake employees (seriously, it happens), or even redirecting funds.

It’s sneaky, but you can be sneakier. On average, payroll fraud lasts 36 months before being detected, costing businesses a median loss of $90,000 (ACFE Report to the Nations 2022).

Here’s how.

Empower Your Team to Be Your Best Defense Against Fraud

Step 1: Use Technology to Your Advantage

You know how there’s a tool for everything these days? Well, payroll’s no different. The more you automate, the less room there is for human error—or worse, dishonesty. Businesses that automate payroll reduce fraud by 15% compared to manual processes (Forrester Research, 2020).

Tools like payroll software can track employee hours, verify tax filings, and even flag unusual activity before it becomes a problem.

Pro Tip: Look for payroll software that includes multi-step authentication and access control. That way, only authorized personnel can get into the sensitive stuff.

Step 2: Separate Responsibilities (Even if You’re a Small Team)

I get it—you’re a small team, and it might seem easier to have one person handle payroll. But here’s the thing: you don’t want to give one person too much control. According to the Association of Certified Fraud Examiners (ACFE), 70% of payroll fraud occurs when a single employee has too much control over payroll processes.

Having separate people handle payroll, approve hours, and review financial reports creates a checks-and-balances system. It’s like your own little fraud protection squad.

Pro Tip: Even if you're a small team, technology can help you implement separation of duties without hiring additional staff. Consider using payroll software that allows you to assign specific roles and permissions to different team members. This way, you can automate approvals, track changes, and get alerts for any suspicious activity, adding an extra layer of protection without overloading your limited resources.

Step 3: Conduct Regular Audits (And Make Them Random!)

Speaking of audits, this one’s big. And you don’t need to be a financial expert to do it. Schedule regular reviews of payroll and bank statements. But here’s the key—mix it up! Do random audits, so there’s no chance for anyone to cover their tracks if something shady is happening.

Pro Tip: You don’t have to do this alone. There are services (yes, affordable ones) that specialize in payroll audits for small businesses.

Step 4: Pay Attention to Employee Behavior

Now, I’m not saying you need to become Sherlock Holmes, but it's important to keep your eyes and ears open. If someone is overly protective of their work, refuses to take time off, or gets cagey when you ask about payroll-related stuff, that could be a red flag.

Interesting stat: Employees who never take time off or who avoid vacations have a higher probability of being involved in payroll fraud. In fact, 40% of fraud cases involve employees who haven’t taken time off in over a year (Workforce Institute, 2021).

On the flip side, creating a company culture where transparency is key makes it less likely for anyone to feel like they can get away with fraud in the first place.

Step 5: Spotting Payroll Phishing Scams

Phishing scams are one of the most common ways payroll fraud happens, and they’re becoming more sophisticated. Payroll phishing attacks surged by 160% in 2021 (Microsoft Security Blog), and small businesses are often targeted because they may not have robust IT defenses.

So how do you spot these scams? Here are the most common ones:

Fake Payroll Direct Deposit Requests
One of the most common payroll scams involves fake payroll direct deposit requests. You or your payroll manager might receive an email that appears to be from an employee requesting a change in their direct deposit information. The email looks legitimate, complete with the employee’s name and signature, but it’s actually from a scammer trying to reroute funds to their own account.

To identify this scam, watch out for small discrepancies in the email domain. For example, instead of “name@payrollservice.com,” the scammer might use “name@payroll-service.co.” It’s essential to always verify any changes to direct deposit information directly with the employee before making any updates.

An example of this type of scam might look like this: “Hi, I’ve switched banks and need to update my direct deposit details. Please change my account to XYZ Bank.”

CEO Fraud (Business Email Compromise)
CEO fraud, also known as business email compromise, is another prevalent payroll scam. This scam involves a hacker impersonating a high-ranking company executive, such as the CEO, and sending an urgent email to the payroll department. The email often demands that payroll send sensitive information, such as employee W-2s or bank account numbers.

To spot this scam, pay attention to the tone of the email. Scammers often use urgent language, like “We need this ASAP!” or “This is an emergency.” Be especially cautious if the request comes from a personal email account or if it seems unusual for the executive to ask for such information.

An example of CEO fraud might read: “Hey, payroll team! I need all employee W-2s for tax purposes by the end of the day. Send them over right away!”

Fake Tax Notifications
Another tactic scammers use is sending fake tax notifications. These emails claim to be from the IRS or a state tax authority, warning about overdue taxes or underpayment penalties. They typically contain a link or attachment that leads to a phishing site or downloads malicious software onto your system.

To avoid falling victim to this scam, remember that government agencies will never request sensitive information via email or threaten immediate legal action. If you receive such an email, avoid clicking on any links or downloading attachments.

An example of a fake tax notification might say: “Your company is under investigation for tax fraud. Click here to pay your outstanding balance or face legal consequences.”

How to Protect Yourself:

• Train your employees to be skeptical of any unexpected or urgent payroll-related requests.
• Always verify changes to payroll information with employees directly (via phone or in person).
• Implement email authentication tools like DMARC or SPF to reduce the likelihood of phishing emails reaching your inbox.

Step 6: Make Your Payroll System Transparent and Secure

Imagine having a payroll process so tight, people think twice before even thinking about fraud. You can do this by making payroll policies crystal clear and communicating them to your team. Transparency builds trust but also sets boundaries, so everyone knows that shady stuff won’t fly.

Oh, and password-protect everything. Like, everything. And change those passwords often, okay?

Step 7: Consider Outsourcing Your Payroll

If payroll fraud still feels like a looming threat, it might be time to outsource. According to a recent study, businesses that outsource payroll reduce fraud risks by 26% compared to those that keep payroll in-house (CPA Practice Advisor, 2022).

It sounds fancy, but trust me, it's not just for the big guys. Payroll services exist specifically to help small businesses avoid fraud, stay compliant with tax laws, and free up your time to do what you do best—run your business.

Stay Vigilant, Stay Safe

Payroll fraud might seem like something that only happens to big companies, but small businesses are often the most vulnerable. The key is to stay vigilant and put safeguards in place before anything goes wrong. By automating your payroll, separating responsibilities, conducting audits, and staying aware of what's going on in your company, you’re already ahead of the game.

So don’t stress—just be smart. You've got this.

What's Next? Taking Action to Protect Your Business

Now that you know the basics of how to protect your business from payroll fraud, it’s time to take some tangible steps forward. 

Start by reviewing your current payroll process, implementing some of the tips we’ve discussed, and ensuring your team is aware of common scams. If it all feels overwhelming or you’re not sure where to begin, you don’t have to go it alone. 

Paragon Payroll specializes in helping small businesses like yours navigate these challenges and keep your payroll systems secure. Whether you need advice, a bit of extra support, or someone to take the entire payroll process off your plate, we’re here to help. 

Reach out to Paragon Payroll, and let’s chat about how we can keep your business safe—so you can focus on what you do best.