How Payroll Scams Happen and How to Protect Yourself

Don't get taken by payroll scams
Payroll fraud and scams is estimated to cost small employers in the U.S. $7,000,000,000!

Key Takeaways on Payroll Security

  • Internal manipulation, identity deception, external infiltration, classification errors, and data diversion are different forms in which payroll scams can happen. Each poses specific threats that demand targeted safeguards.
  • Simple regular audits, strong internal controls, and clear documentation go a long way in catching unauthorized changes and keeping accountability in payroll processes.
  • Sophisticated security measures, such as multi-factor authentication, biometric tracking, and secure payroll software, can drastically decrease the risk of insider and outsider threats.
  • Continuous employee training and open reporting mechanisms foster a culture of awareness, allowing for early identification and reporting of suspicious payroll behavior.
  • We do accurate employee classification, routine compliance checks, and strong verification protocols to avoid misclassifying fraud and rerouting payments.
  • It’s important to support employees with open communication in the wake of payroll fraud, restoring trust and improving the overall resilience of an organization.

Executive Summary For CFOs & Controllers

Payroll fraud represents a material financial, compliance, and reputational risk that extends well beyond simple clerical error. Scams typically arise through five primary vectors:

internal manipulation, identity deception, external cyber infiltration, employee misclassification, and payroll data diversion. Each exploits gaps in controls, oversight, or system design—and many persist undetected for extended periods, with average discovery timelines approaching 18 months and recurring monthly losses.

From a financial leadership perspective, payroll fraud is fundamentally a controls and governance failure, not a payroll-processing issue alone.

Roughly 15% of occupational fraud in the U.S. and Canada is payroll-related, with small and mid-sized organizations facing disproportionately higher risk due to thinner segregation of duties and reliance on legacy processes.

 

Key exposure areas include:

  • Excessive access concentration (single individuals controlling multiple payroll steps)
  • Unverified changes to pay rates, bank accounts, or classifications
  • Insufficient audit trails and reconciliation
  • Human error and turnover, which weaken institutional knowledge and enforcement
  • Phishing and social engineering, which increasingly target finance and HR staff
  • Effective mitigation requires a defense-in-depth approach that combines:
  • Strong internal controls (segregation of duties, dual approvals, documented processes)
  • Routine and exception-based payroll audits
  • Secure payroll technology with MFA, access controls, and anomaly detection
  • Verification protocols for all payroll changes, especially direct deposit updates
  • Ongoing employee training and clear, retaliation-free reporting mechanisms

Beyond direct financial loss, payroll fraud materially impacts employee trust, morale, and retention, often triggering reputational damage and increased turnover. Post-incident recovery depends on transparent leadership communication, rapid response protocols, and demonstrable control improvements.

Payroll scams usually occur when someone deceives payroll systems or personnel to pilfer funds or obtain fraudulent disbursements. Some scams employ fictitious workers. Others modify legitimate payroll data or request fraudulent payment demands.

They use emails, calls, or online forms to perpetrate these scams. To detect payroll scams, it’s useful to be familiar with typical schemes and vulnerabilities in payroll processes.

Here are some of the primary techniques behind payroll scams and how to detect them.

Anatomy of Payroll Scams

Payroll scams, including sophisticated payroll fraud and ghost employee fraud, are costing businesses across the globe millions. They span insider manipulation and timesheet fraud to cyberattacks and payroll diversion schemes. Prevention of payroll fraud requires a cooperative effort involving payroll staff, HR, and IT to detect irregularities effectively.

Here is a quick visual of the most viscious payroll theft scams:

Scheme

Characteristics

Example

Ghost Employees

Fake employees on payroll, siphoning funds

Payroll admin creates non-existent worker

Timesheet Fraud

Inflated hours or rates, unearned pay

Worker reports extra overtime

Payroll Diversion

Redirected payments to fraudster accounts

Phishing tricks staff into change

Classification Fraud

Misclassifying workers to reduce wages/benefits

Labeling full-timers as contractors

Identity Theft

Using stolen IDs to access payroll

Criminals add fake payees

1. Internal Manipulation

Payroll personnel can leverage their system access to illicitly adjust pay rates, generate phantom workers, or manipulate time records. These activities are typically buried in mundane transactions and are not easy to detect without a distinct audit trail.

Checking payroll logs and implementing segregation of duties help make sure no one employee has too tight a grip on the process. Regular audits, for example, can expose anomalies, such as duplicate bank accounts or unexpected pay rate changes.

Robust internal controls, like approval layers and access limitations, minimize openings for deception. Watching for behavioral red flags, like employees who balk at supervision or work odd hours, is crucial to identifying collusion or rogue behavior.

2. Identity Deception

These strategies involve either forging paperwork or hacking HR systems to insert false personnel. MFA and comprehensive background checks for every hire are essential safeguards.

Payroll teams should be hyper vigilant for phishing emails purporting to be legit requests. All these scams attempt to pilfer login details, which lets fraudsters alter payroll data remotely.

PRO TIP:

We have seen a rise in phishing emails to payroll departments that look like they are coming from employees or even executives.  In one instance, a VIP emailed an internal payroll admin asking to change their direct deposit.  That admin did so without hesitation.  About three months later, we took over the payroll as an outsourced payroll firm and found that the change was not requested by the VIP employee.  Some scammer had received over $30,000 direct to a bank account.  We tracked down the email and found that the employee’s gmail address had been hacked. 

*ALWAYS confirm live with an employee that they are requesting a change!

Training employees on how to identify phishing messages can help contain these threats.

3. External Infiltration

Payroll database hackers use malware and social engineering. They might attempt direct access or dupe employees into downloading infected files. Hardening and encrypting protect payroll data.

Regular security audits identify vulnerabilities before they are taken advantage of. Keeping up with phishing trends and promoting a culture of security awareness across the organization can mitigate the risk of infiltration.

4. Classification Errors

This can be intentional or unintentional, yet both ways harm employees and leave businesses vulnerable to litigation. Payroll personnel should be educated on classification regulations and should verify records for inaccuracies.

Ongoing audits and validation steps ensure that every employee is categorized and compensated appropriately. This safeguards both the company and workers.

5. Data Diversion

Fraudsters posing as employees or HR will ask for changes to bank accounts, directing paychecks to accounts they control. Safeguards like needing verbal confirmation for direct deposit changes stop such scams.

Detecting abrupt or large changes to payroll transactions can spot fraud attempts early. Training all employees on the risks of distributing sensitive payroll info beyond secured channels is critical.

High-profile cases prove that even big organizations can lose millions to payroll diversion.

Unmasking Fraudulent Activity

Payroll fraud is a serious threat to organizations of every size, across nations and sectors. It accounts for roughly 15% of all occupational fraud uncovered in the US and Canada, highlighting just how frequent and expensive these cases are. Essentially, payroll fraud is a matter of holes in the way pay is monitored, audited, and distributed, allowing fraud to continue for months or years.

The consequences can be brutal from lost dollars and increased tax obligations to permanent damage to a corporate reputation.

A clever way to expose fraud is to establish a transparent mechanism for reporting any suspicious payroll activity. That means constructing a mechanism that allows employees to highlight odd or suspicious records, such as extended shifts that aren’t consistent with positions held or hours that don’t correspond with project records.

For instance, a manager may be presented with numerous claims for overtime on weekends from employees who very seldom work those days. A mechanism to expediently and safely report such strangeness, with defined actions and zero concern for retaliation, is essential.

When reporting lines are open, scams, such as one that went on for six years and caused two point five million dollars in lost fake expense claims, get uncovered a lot earlier.

Payroll checking isn’t just a checkbox, it’s an actual fraud-finding instrument. With data checks, employers can identify suspicious patterns like large employee pay spikes or shifts that extend beyond normal working hours. Scans for strange time clock usages, such as clock-ins during the night or bogus clock-ins for missing employees, are a boon, too.

Data tools can snatch when one person governs too many steps in payroll, permitting them to slip counterfeit payments by without getting caught.

A work culture that values truth-telling and transparency is equally important. Personnel across the organization must feel they can raise concerns without fear. This can be accomplished by establishing hotlines, open-door policies, or even frequent town halls where troubles are listened to.

When individuals recognize that their voices count, they are more apt to identify holes or deception before it becomes widespread.

To keep one step ahead of evolving scams, frequent training is essential for payroll teams. This assists all of us in identifying new scams, such as phony bank account switches or divided payments to third-party accounts.

Training should address why two managers should verify new hires, why any one person shouldn’t have all the payroll steps, and how to use data checks to identify fraud. By keeping teams sharp, firms can reduce the risk of succumbing to scams that would otherwise slip through.

The Human Element in Fraud

Humans are a key factor in payroll fraud, influencing its frequency and duration. Record gaps, unverified errors and unverified trust create avenues for fraud. The table below shows the impact of human factors on payroll accuracy and fraud:

Human Factor

Payroll Accuracy Impact

Fraud Risk Impact

Lack of oversight

More errors, missed checks

Higher chance of undetected fraud

Trust without verification

Missed double-checks, skipped audits

Easier for scams to go unnoticed

High turnover

New staff may lack training

Weak control, more risk

Poor communication

Misunderstood rules and steps

Gaps that fraudsters can use

Trust and accountability prevent payroll fraud in its tracks. When payroll teams create an environment where all of us audit each other and raise a hand when something seems awry, fraud becomes tough. Trust is not turning a blind eye. It’s about candid conversation and communal checks.

As it turned out, even top people like executives or police captains had abused their power to skim pay; no group was above suspicion. Every pay cycle needs more than one pair of eyes. Common checks and transparent trails cause fraud to pop out more quickly. This is crucial as payroll scams go on for a mean of 18 months before they are discovered, with $2,800 losses per month.

Continued employee training is a key to preventing scams early. Ongoing training assists employees in identifying hazards such as timesheet padding or bogus injury claims and understanding how to respond if they notice something amiss. Payroll fraud accounts for 15% of all workplace scams in the US and Canada, and small and medium businesses are twice as at risk.

Knowing what to watch for isn’t merely nice to have. Employees need to understand how to audit logs, track down mistakes, and safely disclose issues. Training shouldn’t be one-off. It has to catch up with changes in rules and scams.

High turnover makes payroll fraud more likely and more difficult to detect. When companies bring in new people frequently, controls may fail. New workers might not know all the steps or might miss warning signs.

Fraudsters exploit this gap to sneak in bogus hours or phantom employees. In high turnover locations, teams need straightforward, foolproof pay-vetting measures, regardless of who’s on staff. Turnover is not only an HR pain. It’s a tip that payroll checks need to get a little tighter.

Fortify Your Payroll Defenses

Payroll fraud continues to be a worldwide issue, particularly for small and medium-sized companies, which are at twice the risk of larger organizations. Most scams occur when controls are lax or bypassed, and the harm can be permanent. To combat these threats, organizations need a defense-in-depth strategy that includes a mix of technology, process controls, and employee education.

 
 
 

If you haven't considered outsourcing your payroll to an expert Payroll Outsourcing frim like My Virtual HR Director, then now may be the time.  We have the skills and the cybersecurity to keep your payroll data and processes safe!

 

The following numbered best practices can help safeguard payroll data and reduce the likelihood of scams:

  1. Strengthen your payroll armor

  2. Install automated staff time and attendance management software to precisely track when your employees work, bolstering your pay defenses by blocking timesheet fraud and overpayments.

  3. Build communication channels for promptly reporting discrepancies so employees can easily alert you to suspicious action.

  4. Fortify Your Payroll Defenses with internal controls. Conduct regular audits to ensure payroll security compliance. Examine payroll records for anomalies or discrepancies that indicate fraud.

  5. Use strong payroll systems with direct deposit and e-payment capabilities, reducing avenues for manual interference.

  6. Educate your employees in security awareness, particularly on BEC and payroll diversion.

  7. Invest in machine learning and advanced threat detection to identify and intercept phishing or payroll diversion attempts.

Process Controls

A clear checklist is critical to maintaining all process controls in check for payroll modifications. Fortify Your Payroll Defenses. Every change — whether it’s adding a new payee or updating account information — has to be reviewed and signed off by two authorized individuals. It minimizes the possibility of unauthorized modifications.

Positive pay systems can validate that only authorized transactions go through, which catches bogus input before the funds leave the organization’s accounts. Documenting all payroll processes creates a transparent audit trail. This is important for liability purposes if there is an incident.

Routine audits of payroll processing can usually find gaps or legacy steps. Modernizing these processes does make scams less probable, particularly combined with regular reconciliations and outside audits. The objective is to maintain transparency and get everything up to date.

Technology Shields

Embracing cutting-edge technology, like payroll software with integrated fraud detection, aids in identifying suspicious trends before they turn into theft. Fortify your payroll defenses.

Machine learning and threat detection tools scour payroll data and emails for signs of diversion attacks. By staying up to date on cybersecurity trends, you’ll make sure your defenses are on par with new threats. Technology should never take the place of human oversight; it should always come behind it.

Employee Education

  • Short online courses on payroll security
  • Guides for spotting phishing emails
  • Access to reporting tools for suspicious activity
  • Simulated phishing exercises

Incentivize all to flag weird emails or unusual payroll messages, as part of payroll fraud prevention. Fortify your payroll defenses by building a culture where employees are vigilant against common payroll scams.

The Psychological Aftermath

Payroll scams do more than just damage your wallet. When workers discover their wages have been hijacked, the initial blow is psychological. They can experience deep anxiety, shame, or even anger. Many are left unable to sleep or concentrate, at times for weeks. Some even suffer from depression or PTSD, illustrating how real and profound these wounds can become.

In one poll, two-thirds of scam victims reported that the deception had left them emotionally drained, to the point where some confessed the suffering was so intense they contemplated suicide. These are not isolated incidents; this degree of stress and depression is prevalent, regardless of nation or culture, highlighting the impact of common payroll frauds.

Most people blame themselves even when it’s not their fault. Some 47% of recent study respondents felt guilty, and 61% thought they were too trusting. For many, this self-blame is more painful than the lost cash. The shame will prevent them from informing anyone about the payroll scam that occurred.

Actually, 85% of victims never even report the scam. They remain silent out of shame or because they believe it’s irreparable. This silence can exacerbate the duration of the injury and isolate victims from needed support.

When a scam strikes, having support systems is crucial. Companies can establish help lines, link workers to counselors, or conduct group sessions. It is essential to talk about what happened, so workers know they’re not alone in facing payroll fraud schemes.

Things as simple as transparent updates about the fraud, open conversations with leadership, and check-ins from HR can assist. If guilt, shame, or stress begin to affect how someone lives or works, seeking help from a counselor is warranted. It can make the difference between a short setback and a long struggle.

The impact doesn’t end with the scammed victims. Payroll fraud can absolutely break the trust in a company. Employees might think, "Is my boss concerned? Am I secure?" Morale sinks, and others consider leaving the organization.

Around 45% of victims cease patronizing the bank or group where the fraud occurred. This type of loss demoralizes teams and can damage the company’s reputation for years, leading to significant financial repercussions.

To repair trust, companies have to demonstrate actual change. Leaders need to be transparent about what failed and what they are doing to prevent it from happening again. Frequent check-ins, transparent pay stubs, and quick responses to inquiries go a long way to restore trust in the payroll system.

Training sessions about how scams work can help workers feel more in control and less likely to blame themselves. With consistent effort, trust can return, but this is not quick or easy, requiring ongoing payroll fraud prevention methods.

Responding to a Breach

A payroll breach requires a response plan that is obvious, immediate, and straightforward. Because payroll fraud is notoriously undetected, it tends to linger for a long time, typically 18 months, with an average loss of $2,800 a month. Speed is a factor. A good plan defines who does what, where, and with what tools to prevent further damage.

It should include making a Rapid Response Team. This team, comprised of trusted personnel from IT, HR, and management, can mobilize at the first sign of trouble. Quarterly tabletop exercises keep this team sharp. These drills demonstrate how a breach could play out and help identify holes in the plan.

When a breach is discovered, it’s crucial to communicate with those impacted immediately. Since so many scams utilize phony emails or payroll changes, candid language goes a long way in establishing credibility and quelling alarm. They want to hear nothing about a breach. Just 3% of employees report phishing emails.

Regular monthly reminders and open discussions of new threats boost the figures. Employees should know it’s safe to come forward and report anything strange. This is frequently the first line of defense.

Law enforcement and outside experts must be brought in quickly. Cybersecurity teams assist in tracking back what went wrong and how. They can discover if information has been compromised or altered. Cooperating with law enforcement is required to trace stolen funds and if feasible, recover some of them.

These pros counsel on how to prevent a repeat. In the aftermath of a breach, audit all payroll rules and controls. This means verifying that responsibilities are divided properly. No one worker should be in charge of the entire payroll process.

Revoking payroll access for staff who leave is a necessity. Training new hires on security from day one is also essential. Training is not a one and done process. For breaches with 82% human error associated in some way, frequent updates hold value.

By providing security training each quarter and issuing monthly tips, you keep everyone aware of emerging threats. The takeaways from any breach should be better rules, tools, and habits.

Fortify Your Payroll

To detect payroll scams, look for unusual pay alterations, fictitious employee records or suspicious emails. Scams strike quickly, and people can overlook minor indicators in their hurry to get things done. Controls gaps or legacy tools easily let cheats slide in. Teams who chatter, audit, and safe-log in prevent most incidents. Training helps people trust their gut and flag weird things. Post-breach, transparency and fast responses get employees to believe in the system again. It’s not just about technology, it’s about caring people building a great payroll setup. Be vigilant, seek assistance, and keep abreast of new schemes. For your own tips or to read more, visit our blog and join the discussion.

Frequently Asked Questions About Payroll Security & Payroll Scams

What is a payroll scam?

A payroll scam is a form of financial fraud in which criminals exploit payroll processes, payroll administrators, or payroll software to illegally redirect wages, steal company funds, or manipulate employee pay records. Modern payroll scams rely heavily on social engineering, not technical hacking, making even well-run organizations vulnerable if controls are weak.


How do payroll scams usually happen?

Most payroll scams start with impersonation and urgency. Attackers pose as employees, executives, or vendors and request payroll changes such as direct deposit updates, off-cycle payments, or emergency corrections. These requests often look routine and are timed to pressure payroll staff into acting quickly, bypassing verification steps.


What is direct deposit fraud?

Direct deposit fraud occurs when a criminal successfully changes an employee’s bank account information so payroll funds are deposited into an account controlled by the attacker. This is one of the most common payroll scams because the change may not be detected until payday, at which point funds are often unrecoverable.


Who is most at risk for payroll scams?

Organizations of all sizes are at risk, but small and mid-sized employers are disproportionately targeted. Companies where payroll is handled by one internal employee—or where payroll and HR duties overlap—face the highest risk due to limited segregation of duties and fewer review controls.


What are the most common payroll scams today?

The most frequent payroll fraud schemes include:

  • Direct deposit change scams
  • Executive or CEO impersonation requests
  • Ghost employee payroll fraud
  • Payroll tax diversion schemes
  • Time theft and falsified timesheets
  • Compromised payroll system credentials

These scams exploit trust, familiarity, and informal internal workflows.


What are warning signs of payroll fraud?

Common red flags include:

  • Urgent or last-minute payroll change requests
  • Requests that bypass normal payroll procedures
  • Bank changes made close to payroll processing deadlines
  • Emails sent from personal or slightly altered addresses
  • Payroll discrepancies that cannot be explained by system errors

Any deviation from standard payroll procedures should be treated as a potential fraud indicator.


How can companies protect themselves from payroll scams?

Effective payroll fraud prevention requires process controls, not just technology. Best practices include:

  • Multi-factor authentication for payroll systems
  • Dual approval for payroll changes
  • Written verification for direct deposit updates
  • Pre-submission payroll review by management
  • Regular payroll audits and reconciliations
  • Ongoing employee training on phishing and impersonation scams

Technology alone is insufficient without disciplined procedures.


Why is outsourced payroll more secure than in-house payroll?

Outsourced payroll significantly reduces fraud risk because external payroll professionals are not part of internal social networks. They are insulated from office relationships, informal requests, and peer pressure that often enable payroll manipulation. This independence makes bribery, favoritism, and “help a coworker out” scenarios virtually impossible.


How does outsourcing payroll to My Virtual HR Director reduce payroll fraud risk?

My Virtual HR Director inserts independent controls into the payroll process, including documented change verification, separation of duties, and structured management review before payroll is finalized. Payroll is processed by experts who are external to the organization, eliminating social engineering vulnerabilities common in in-house payroll models.


Why is management review before payroll submission important?

Management review acts as a final safeguard against payroll fraud. Reviewing payroll registers, bank account changes, and variance reports before submission significantly increases the likelihood of detecting fraudulent activity or errors before money is released.


What should you do if you suspect a payroll scam?

If payroll fraud is suspected, payroll processing should be paused immediately. Access credentials should be secured, leadership notified, and the payroll provider contacted. Early intervention is critical—once payroll funds are released, recovery is often difficult or impossible.


What are the consequences of payroll fraud for businesses?

Payroll scams can result in financial losses, regulatory penalties, tax compliance issues, employee distrust, and reputational damage. Employers may still be legally obligated to pay affected employees even if stolen wages cannot be recovered, compounding the financial impact.


Can payroll scams be completely prevented?

No system is completely immune, but payroll scams can be dramatically reduced with independent oversight, strong internal controls, and professional payroll administration. Organizations using outsourced payroll with structured review controls experience significantly fewer incidents and faster resolution when issues arise.

The Ultimate Payroll Security Solution

Payroll scams, such as ghost employee fraud and sophisticated payroll frauds, can lead to financial loss, erode trust, and negatively impact employee morale.

Payroll fraud doesn’t usually happen because companies don’t care. It happens because internal payroll is exposed by design—too much access, too much trust, and too many opportunities for error, collusion, or manipulation.

The most effective way to eliminate those risks is straightforward:

Remove payroll from inside the organization.

Why Outsourcing Payroll Is the Strongest Security Control

Outsourced payroll isn’t just operationally efficient—it is a structural security upgrade.

When payroll is handled by My Virtual HR Director (MVHRD):

  • Payroll is processed by independent specialists who are not embedded in office relationships, social dynamics, or internal politics
  • Opportunities for time padding, favoritism, collusion, or “friendly” overrides disappear
  • No single internal employee controls pay data, bank changes, classifications, or submissions
  • Every payroll run follows documented controls, review steps, and audit-ready procedures

This separation alone eliminates many of the most common payroll fraud vectors.

Built-In Controls You Don’t Get In-House

MVHRD’s outsourced payroll model includes:

  • Dual-review and management sign-off before payroll is finalized
  • Secure verification protocols for employee changes and direct deposit updates
  • Ongoing compliance and classification checks
  • Consistent audit trails and exception reporting
  • Payroll professionals trained specifically to spot fraud patterns and anomalies

Instead of reacting to payroll risk, you design it out of the system.

The Simple, Secure Path Forward

  1. Recognize the risk – Internal payroll is one of the highest-trust, lowest-visibility functions in any organization
  2. Reduce exposure – Move payroll out of internal hands and into a controlled, third-party environment
  3. Gain confidence – Know that payroll is accurate, compliant, and independently reviewed every cycle

Take the Next Step

If payroll security, compliance, and peace of mind matter to you as a CFO or Controller, outsourcing payroll is no longer optional—it’s the safest architecture available.

👉 Visit My Virtual HR Director’s Payroll Services page to see how secure, controlled payroll outsourcing works and schedule a confidential consultation.

Stop managing payroll risk internally.
Outsource it—and eliminate it.