Payroll Fraud: Schemes, Examples & How to Prevent Them in 2025

Payroll fraud is among the most common forms of employee fraud. According to the Association of Certified Fraud Examiners (ACFE), organizations lose an estimated 5% of annual revenue to fraud, with asset misappropriation like payroll schemes accounting for 89% of occupation fraud cases, averaging $120,000 per case. 

Beyond financial losses, payroll fraud has a personal cost and undermines the sense of trust that’s essential in an employee-employer relationship and in running an operational business. Companies may also commit payroll fraud themselves as part of criminal schemes like money laundering or tax evasion.

Payroll fraud can be a difficult challenge to address, but it is nonetheless one that can seriously impact both a company’s finances and its reputation. By understanding how these schemes work and how to prevent them, businesses can build stronger defenses and a better working culture.

What is payroll fraud?

Payroll fraud is a form of employee fraud where individuals manipulate a company’s payroll processes. This is often to obtain payments individuals are not entitled to, and it may involve:

• Falsifying work records, such as inflating hours or claiming unworked overtime
• Creating non-existent or illegitimate payees to divert funds
• Misrepresenting status or performance to increase pay
• Unauthorized redirection of wages, e.g., changing direct deposit information.

Payroll fraud can also be executed by external actors, such as contractors, who can exploit the company’s payroll systems.

Most common payroll fraud schemes

1. Ghost employees: Fraudsters may add fake employees to the payroll or keep former employees on the payroll, receiving pay for work they have never done. 
2. Phantom contractor schemes: These are similar to ghost employees, but targeting outsourced or temporary staff; payments are issued for non-existent contractors. This scheme is also used for money laundering.
3. Timesheet fraud: Employees may overreport the hours they have worked or claim unapproved overtime to receive more pay.
4. Multiple job reporting: Employees may be claiming to work on more than one full-time role at a time, fraudulently collecting pay from multiple employers.
5. Unauthorized benefit claims: Employees may claim benefits they’re not entitled to, inflating their compensation.
6. Buddy punching: An employee may clock in or out on behalf of a coworker, potentially disguising unworked time due to absenteeism.
7. Commissions and bonus fraud: Employees or companies may falsify sales or performance figures for bigger payouts.
8. Payroll diversion: Criminals are known to use phishing or social engineering to access personal information and reroute pay from employees to unauthorized bank accounts.
9. Advance or loan fraud: Employees may request salary advances or company loans with no intention of repaying them.
10. Expense reimbursement fraud: Employees or companies themselves may falsely report expenses to receive payments or reduce their tax burdens.
11. Pay rate alteration: Employees or contractors may misrepresent their pay rates to receive a larger payment.
12. Repeat payment fraud: Vendors and employees may generate invoices or bills and request payments that they have already received.
13. Overpayment due to system errors: Employees may exploit payroll system glitches to receive higher pay and conceal it as an error.  

Who commits payroll fraud?

People inside or outside an organization can commit payroll fraud. This can include: trusted employees, executives and senior staff who may misuse their authority, contractors, remote workers with less supervision, fraudsters using synthetic identities, cybercriminals who alter payroll details, opportunists under economic hardships, and repeat offenders who learn how to cheat the system. 

Internally, HR staff and payroll or accounting employees may abuse their access to payroll systems to manipulate records or create ghost employees. Externally, contractors may collude with insiders or exploit vulnerabilities to siphon off funds. Cybercriminals may also fraudulently alter payroll details to steal company payments. 

AI tools are also being increasingly used to facilitate payroll fraud schemes. Fraudsters are able to use AI agents to automate attacks or better disguise their identities, making fraud harder to detect. Real-world cases show AI being exploited in costly impersonation scams. For example, deepfake audio and video have been used to trick employees into approving fraudulent payroll changes, with documented cases including a UK energy CEO tricked by a “boss” into transferring €220,000 (~$260,000), and a UAE bank manager conned by a cloned client director’s voice into authorizing transfers totaling $35 million.

Since threats can come from various actors and are now fueled by AI, it’s important for any company to adopt reliable AI-powered fraud prevention software.

Suggested read: Know Your Machines: AI Agents and the Rising Insider Threat in Banking and Crypto

Real-life payroll fraud cases and examples

• A council worker in the UK simultaneously held four jobs across different local authorities, submitted false timesheets, and received over £230,000 ($311,000) before getting caught.
• An HR manager in Shanghai, China, created 22 fake employees over eight years, siphoning off approximately 16 million yuan ($2.2 million) in pay.
• Almost half of the US Postal Service’s employees had “unauthorized overtime” in 2019, incurring about $521.6 million in dubious overtime costs.
• A corruption scandal shook Vietnam when the Vạn Thịnh Phát corporate network orchestrated fraudulent loan disbursements targeting the Saigon Commercial Bank, totaling billions of US dollars.

How payroll fraud affects businesses

According to the ACFE, payroll fraud accounts for 15% of all occupational fraud schemes in North America and typically lasts around 18 months, costing businesses an average of $2,800 per month. So, payroll fraud directly drains financial resources, increasing operating costs. However, it isn’t just a financial burden, as it sometimes exposes companies to legal or regulatory penalties. Payroll fraud also undermines employee trust, damages company culture, and diverts time and resources away from growth as management has to deal with investigations, audits, and recovery efforts.

Legal consequences of payroll fraud

Payroll fraud is a criminal act in most jurisdictions, and payroll fraud punishment is potentially severe depending on the scale and local laws. 

Consequences may include:

• Fines and restitution
• Criminal charges like embezzlement, tax evasion, or fraud 
• Prison sentences 
• Tax penalties
• Civil lawsuits
• Professional consequences.

For example, in some US states like Connecticut, wage theft above certain amounts is classified as a felony punishable by fines up to $10,000 and prison time. Colorado treats intentional wage underpayment or withholding as a felony with possible incarceration up to five years.

In the UK, payroll fraud involving PAYE tax evasion can lead to prison sentences of up to seven years or even a life sentence in extreme cases.

Suggested read: Employment Verification: What It Is and How to Simplify the Process (2025)

What are the red flags of payroll fraud?

While payroll fraud can often fly under the radar, there are a number of warning signs that warrant further investigation:

• Unexplained changes to records 
• Employees start living beyond their means
• Unexpected payroll communications and access
• Duplicate or multiple payments 
• Missing records
• Payroll records not matching HR data 
• Payments issued to ex-employees or individuals with identical information
• Consistently high overtime hours without clear reasoning
• Requests to send wages to new or suspicious accounts
• Employees sharing bank accounts
• Resistance to audits or reviews

Payroll fraud vs salary fraud vs paycheck fraud

These terms often get confused because they overlap, but there are subtle distinctions:

Term	Definition	Typical examples
Payroll fraud	Payroll fraud is a broad category of employee fraud where payroll systems are manipulated to make unauthorized payments.	Ghost employees, timesheet fraud, buddy punching, paycheck diversion.
Salary fraud	Salary fraud is the misrepresentation of a salary to receive higher pay or benefits, including claiming to be on a higher salary for more hours and providing false information to third parties.	Inflating job titles, misrepresenting salary on a loan.
Paycheck fraud	Paycheck fraud is direct tampering with individual paychecks or payment methods to divert funds.	Forging or altering checks, rerouting direct deposits, cashing duplicate checks.

Suggested read: The Top-6 Most Common Employee Frauds—How to Minimize Internal Fraud

How to prevent payroll fraud

Payroll fraud can be hard to prevent, but a simple mix of vigilance, sound internal controls, and knowing what to look out for can make it much harder for fraudsters to succeed. Generally, monitoring changes in payment and employee details, securing systems, and encouraging transparency can help companies cut their risks. Here are some simple ways to safeguard payroll processes:

• Verify employee identities
• Monitor for changes like new hires, bank account details, pay rates, and addresses
• Maintain payroll activity logs
• Conduct background checks
• Warn employees that payroll fraud is being monitored
• Train employees to spot signs of payroll fraud
• Conduct internal and external payment audits
• Monitor how payments are made
• Use two-step authentication or biometrics on timesheets
• Review access permissions
• Segregate and rotate payroll duties to prevent abuse
• Secure the computer used for payroll activities
• Change passwords whenever there is a change in payroll staff
• Restrict system access to authorized staff
• If something doesn’t feel right, investigate.

Best internal controls to detect payroll fraud in 2025

Strong internal controls are essential for preventing payroll fraud. The payroll internal controls best practices listed in the checklist below help spot irregularities early and reduce opportunities for misconduct:

✅Verify all employee identities
✅Have up-to-date anti-virus and anti-malware software
✅Match payroll data with HR records
✅Conduct surprise audits
✅Set up system alerts to track all changes in payroll data
✅Consider outsourcing to a trusted provider

Payroll fraud prevention software: What to look for in 2025

In addition to spotting red flags and implementing effective internal controls, anti-fraud software is a key part of defense against payroll fraud. Modern payroll fraud software and employee fraud detection tools can help to automate monitoring, using AI and device intelligence to detect anomalies. Businesses should look for:

• Red flag detection: AI-driven monitoring that continuously tracks user behavior and payroll activity to detect anomalies in real time.
• Identity verification for employees: including multi-factor authentication and liveness checks as extra layers of protection, such as when suspicious activity or logins are detected.
• Device intelligence and fraud network detection: to help flag if the same person or device is trying to create multiple employee records or access payroll systems from unrecognized devices.
• Transaction monitoring: to detect irregular payroll events, such as sudden spikes in employee reported hours, unexpected bonuses, or multiple payments going to the same bank account.
• Account takeover protection: combining device and behavioral analytics to stop fraudsters from accessing payroll systems. For example, if a fraudster phishes a payroll manager’s credentials, an unrecognized device or login location could trigger a block.

Effective anti-fraud software ensures that everyone who should be on the payroll is on the payroll, while also minimizing exposure to fraud and compliance breaches.

• What is an example of payroll fraud?

  There are many types of payroll fraud, but a common example is the creation of a ghost employee, where a fake worker is put on the payroll and their wages are diverted to the fraudster. Other examples include inflating timesheets or misclassifying employees to gain higher pay.

• How can payroll fraud be detected?

  Payroll fraud can be detected through regular audits, software that detects red flags, and checking payroll data against HR records. Red flags include missing records, unexplained payroll changes, or multiple employees sharing the same bank account.

• What are the different types of payroll fraud schemes?

  The most common schemes include ghost employees, timesheet fraud, buddy punching, commission or bonus fraud, paycheck diversion, and worker misclassification.

• How can small businesses prevent payroll fraud?

  Small businesses can prevent payroll fraud by segregating payroll duties and using payroll software with fraud detection features. Regular audits, sound cybersecurity practices, and employee verification also help prevent fraud.

• Is payroll fraud a criminal offense?

  Yes. Payroll fraud is considered a criminal offense in most jurisdictions and may be prosecuted under charges such as embezzlement or tax fraud. Penalties range from fines to imprisonment, depending on the scale and jurisdiction.