Payroll Risk Management Strategies

No matter the size or nature of your business, payroll is something you have to monitor and manage carefully. The payroll process can be complex to understand, especially as the rules and regulations governing it are numerous and constantly changing. If you fall foul of legislation, you could face steep payroll penalty fines, potentially damaging your reputation in the market and the eyes of your customers and employees.

But the potential risks associated with payroll go beyond non-compliance with regulations (intended or unintended). Other potential pitfalls include human error, negligence, fraud, natural disasters, and technology failures.

In this article, we’ll share some best practices for developing a payroll risk management strategy. We’ll also explore how leveraging digital technology can help employers mitigate some of the most common payroll risks and challenges.

Common Payroll Risks and Challenges

Here are the top 10 most common payroll risks and some of the strategies you can implement to avoid or mitigate them:

1. Employees Who Don’t Exist

Yes, you read that right. Unfortunately, “phantom employees” are alive and well in our modern workplace. These individuals are people who either genuinely exist on paper only and are being paid “under the table” or who are deceased. Sadly, in cases where such errors are intentional, it’s not uncommon for those in positions of power or who are responsible for managing the payroll to be involved in this flavor of fraud.

2. Padding of Hours

More than half (58.1 percent) of the US workforce is paid according to the number of hours or days they work. Padding of hours happens when somebody misrepresents or overstates the amount of time they’ve been on the job. Legacy timekeeping mechanisms such as manual employee time clocks often fall short of preventing this type of payroll fraud.

Remote working arrangements where people are allowed to perform their jobs from home can also result in the padding of hours creeping in.

3. Incorrect Categorization

A common area where companies fall in their payroll management is the incorrect categorization of different employee types. For example, if you use the services of freelancers and contractors, you’re not required by law to pay taxes on the fees you pay them. It follows, therefore, that contractors and freelancers should not be included on your payroll but rather classified as a business expense.

4. Inadequate Security

Like any corporate system that contains confidential and personally identifiable information, payroll platforms require an additional layer of security. Hackers are known to target small and medium-sized businesses precisely because of their lack of rigor in payroll security protection.

5. No Emphasis on Compliance

There is a multitude of laws that govern employee compensation, tax, and payroll activities. These regulations exist at federal, state, and local levels. Payroll compliance includes tracking data such as hours worked, wages, overtime, and deductions, and reporting them accurately.

6. Failure of the System or Data Loss

System failures and data loss can result from unforeseen events such as natural disasters, equipment breakdowns, or cybercrime. Phishing scams and ransomware attacks have become common threats, compromising sensitive employee and financial data.

7. Knowledge of the Business and Technical Compatibility

Outsourcing payroll can introduce risks such as lack of familiarity with your business, delays due to technical incompatibilities, or even fraudulent activities by external payroll providers.

8. Staff Turnover

If payroll is managed in-house, disruption due to employee turnover can cause challenges. This is particularly problematic if manual systems are still in use.

9. Legal and Tax Woes

Compliance with state and federal payroll laws is critical. For instance, some states mandate semi-monthly payments. Failure to comply can lead to hefty penalties from the IRS, which rarely accepts ignorance as an excuse.

10. Fraudulent Behavior

Segregating payroll duties and conducting thorough background checks can help prevent fraud. Allowing only authorized personnel access to payroll data is essential to reduce risks.

Identifying and Mitigating Payroll Fraud and Other Risks

Planning and leveraging technology can significantly mitigate payroll risks. Here are our top 4 recommendations:

1. Audits and Changelogs

Regular external audits ensure payroll accuracy and transparency. Maintaining changelogs ensures only authorized personnel make modifications to payroll data.

2. Check Calculations and Payment Restrictions

Always have a secondary person review payroll calculations and transactions. Revoking access for former employees is also critical.

3. Conduct Analyses of Variance on a Regular Basis

Regular variance analysis between payroll budgets and actual spending can help detect discrepancies early.

4. Be Diligent About Record-Keeping

Good payroll practices require maintaining detailed employment and payroll records. Investing in digital record-keeping systems and off-site backups adds an extra layer of protection.

The Role of Technology in Payroll Risk Management

Modern technology provides solutions to streamline payroll processes and mitigate risks. Let’s explore some technology-enabled solutions:

On-Demand Pay and Payroll Cards

Earned Wage Access (EWA) allows employees to access their earnings when needed, reducing dependence on payday loans. Payroll cards facilitate direct deposits and on-demand payments.

On-Demand Pay Apps

On-demand pay apps offer employees secure and convenient ways to access earned wages. These apps often include additional financial wellness resources, such as budgeting tools and savings calculators, to help employees better manage their finances.

Learn more about Payactiv’s service here.