Spotting and Preventing Fraud in Small Businesses: Tips for Small Business Owners

Many of us know stories of small businesses succumbing to fraud committed by employees and third parties whether that is employees embezzling funds or third parties scamming business owners out of the company’s cash flow. In either event, individuals can be quite clever in disguising fraud or passing off a scam as legitimate. Business owners should be prepared to spot signs of fraud and have tools in place to prevent fraud in the business. Below are signs of fraud common in small businesses and tips to prevent such fraud from occurring.

Issue: A long-term employee who handles all aspects of writing checks and collecting funds has been embezzling funds for years. Many business owners have experienced some form of this where an employee or bookkeeper who handles all aspects of accounts receivable and accounts payable has improperly kept money for him or herself. Surprisingly, it is often a trusted loyal employee who is found to have been perpetuating the fraud over some period of time and that employee has little to no oversight from the business owner. To prevent such a situation, you should

• incorporate an oversight process,

• establish segregation of duties, and

• require dual controls for any person to move funds in and out of a bank account.

For example, you may consider having one employee writing checks, but to withdraw or make payments over a certain amount, two employee signatures are needed. Similarly, the person collecting the accounts receivable may report to another individual who actually deposits the accounts receivable. Finally, employees should not share passwords related to a company’s funds or bank accounts and each employee should have a separate user name and log in. This makes it easier to track who is doing what with regards to your company’s funds and allows you to minimize the number of employees accessing this sensitive information.

Issue: Employees writing unauthorized checks out of the company bank account. One of the most common examples of small business fraud is employees writing checks to themselves from the company bank account. Specifically, a trusted bookkeeper or individual who handles the checks will write unauthorized checks out of the company’s bank account. Many business owners are effective in delegating duties; however, if an employee with the authority to write checks has little to no oversight, the possibility for fraud exists. To prevent such a situation, most banks offer a service called Positive Pay. Positive Pay is an automated fraud detection tool offered by most banks. Specifically, business owners send the bank a list of checks written and the bank matches the account number, check number and dollar amount of each check to the list provided by the business owner. If the checks do not match up, the bank notifies the business owner who then has the authority to approve or deny the check.

Issue: Employees intentionally or inadvertently wire funds for fraudulent purposes. For example, an employee may set up an ongoing wire to his or her personal account or an employee may inadvertently wire funds to a vendor without prior authorization to do so. Additionally, if such wire transfer was fraudulent or inadvertent, business owners only have 24 hours to notify the bank of such issues otherwise the bank may not be liable for executing such transfer. To prevent such situations, business owners can establish ACH filters or ACH blocks with their banks. ACH filters allow you to protect your company’s cash flow by setting up parameters of when your approval is needed before ACH debits are transferred out of your account. Additionally, you can receive email and text alerts of wire transfers over a certain dollar amount, so you are aware of funds going in and coming out of your company account to better understand your company’s cash flow. Similarly, another tool is to use an ACH block which protects your bank account from unauthorized electronic charges. Similar to an ACH filter, the ACH block will only process ACH payments authorized by you and block all other requests.

Bringing it all together: Business owners should consider implementing some of the prevention tips listed above. Putting dual controls in place and using tools offered by your bank will help prevent fraud in your company. In addition, by letting your employees know that these systems are in place, you are communicating to them that their actions are being monitored, which may prevent them from attempting fraudulent acts.

Is Your Worker an Employee or an Independent Contractor: Why it Matters

Determining whether your current staff and next hires are employees or independent contractors is not an exact science. We can help clarify this determination by explaining the tests that will help you decide whether a worker is an employee or an independent contractor and the implications of both.

Why Does Classification Matter?

Knowing if you have an employee or an independent contractor is important for a variety of business and compliance issues. Many business issues such as Federal and state taxes, employee benefits, ERISA compliance, and civil liability, hinge on whether or not a person is an employee or an independent contractor. For example, generally, your company is responsible for any liabilities caused by an employee, but not by an independent contractor. Likewise, for employees, your company is responsible for paying the employer portion of Social Security, Medicare and sometimes state unemployment taxes.

Misclassifying a worker can lead to a host of unwanted issues including penalties, taxes and fees. Therefore, knowing whether a worker is an employee or independent contract is important. Additionally, knowing these tests can help you properly classify a worker in the beginning of your relationship avoiding any repercussions of misclassification.

How Do You Know?

Three major categories are used to help determine the difference between an employee and an independent contractor: (1) behavioral factors, (2) financial factors, and (3) the nature of the relationship. No one factor is dispositive; instead, it is a weighing of several points in each category.

Behavioral Factors

Behavioral factors include the type and degree of instructions given, the measure used to determine a completed job, and the amount and duration of training. The more instructions and the more details given, the more likely the worker is to be classified as an employee. If you tell the worker when and where to do the work, which equipment or tools to use, where to purchase any supplies, what steps to take to complete the work, and which people should perform which tasks, then most likely this is an employee. The key factor is determining if the business has the right to control the details of the worker’s performance, even if little or no instruction is necessary.

How you evaluate the job after completion is also a factor. If you measure how the work was done, instead of the end result, this evaluation system suggests you have an employee. Training the worker on how to do the job also suggests that a worker is an employee, particularly if you have continual training or more than one training session.

Financial Factors

Financial factors tend to be a little trickier to evaluate because these factors cannot be applied across all types of services. For example, one factor that tends to show that a worker is an independent contractor is significant investment in the tools or equipment that the worker uses. However, this factor is not quantifiable; meaning, no dollar minimum qualifies as a “significant investment”. Additionally, some jobs, particularly in construction, where a worker buys his own tools, are still classified as employee positions.

Other financial factors that suggest a worker is an independent contractor are (1) unreimbursed expenses, (2) opportunity for profit or loss, (3) ability to seek out other business opportunities in the market, and (4) payment based on a flat fee per job, rather than payment on an hourly or salary basis. For example, independent contractors will typically have their own overhead costs, such as tools, equipment, insurance and other unreimbursed expenses. Thus, an independent contractor has the potential to lose money on a job; while an employee does not have this same risk.

Nature of the Relationship

The nature of the relationship refers to the interactions between the worker and the employer. Several factors can be weighed to determine the nature of the relationship, such as written employment contracts, employee benefits, the permanency of the relationship and whether or not the services provided are a key activity of the business. A written contract outlining the worker’s expectations and duties is helpful for making a determination on the type of worker; however, if your company has a worker that meets all of the factors for an employee, you cannot call them an independent contractor in their contract to avoid the employee classification. Likewise, if your company provides the worker with vacation pay, health insurance and a retirement plan, you are suggesting that the relationship will be ongoing, rather than specific to a project or predetermined period. Not providing workers with benefits does not mean they are independent contractors rather than employees.

You should also evaluate the services that the worker provides to your business. If the services are a key aspect of your business, this suggests the worker is an employee. For example, if you own a painting company and hired a worker to work at your office, answer phones calls, book appointments, handle client complaints and reorder office supplies, then this individual is an employee. On the other hand, if the computer system failed and you hired somebody to repair the system, you likely hired an independent contractor. The first worker is necessary on a long term basis to make sure that the company’s primary business runs smoothly, while the second worker is needed to complete a one-time project.

Summary

No one factor will determine a worker’s status and no specific number of factors will automatically classify a worker as an employee or independent contractor. Instead, evaluate each factor as a piece of the whole and look at the entire employment relationship. If after careful evaluation you are still unsure of a worker’s status, for tax purposes, you can seek a determination from the IRS using Form SS-8, available at the IRS. A determination from the IRS can be a lengthy process.

In addition to independent contractor and employee classifications, for tax purposes, workers have additional classifications for statutory employees and statutory nonemployees.