June 2018 eNewsletter

Solving the Mystery of the Phantom Employee

Nathan Oswald, Senior A&A Manager, Cassady Schiller CPAs & Advisors

Do you have ghosts on your payroll?

Thousands of dollars to bogus salary and bonus expenses are lost each year because ghosts exist on the payroll of many companies. Here’s how phantom employee frauds work, including the warning signs and tips to help “exorcise” these scams from your payroll records.

Real Life Example

Phantom employees can be make-believe people or, more likely, real people who are in cahoots with an individual who’s in charge of payroll records. For example, a senior director for a health insurance company recently pleaded guilty to setting up his wife and another person as phantom employees. The director’s wife, who supposedly worked from home, performed no services for the company but earned wages and bonuses totaling more than $785,000.

The other phantom employee, a friend of the director, was paid $61,000. The director entered false documents, such as performance reviews and other reports, into the company database and altered emails to justify the payments.

Opportunity for Fraud

It may seem easier to hide phantom employees in large businesses, especially those with multiple locations and offsite payroll departments. But small firms can be victims, too. All it takes is a rogue employee who’s in charge of authorizing transactions or has other access to the payroll system. These scams require three simple steps:

  1. Put the phantom on the payroll. This can be as simple as adding a fictitious name to the payroll system or using the name of an employee who’s retired or otherwise left the company. If the criminal doesn’t have access to the system, he or she might have to forge documents to create a fictitious account.
  2. Create wage records. If the phantom employee is paid a regular salary, it may not be necessary to fabricate time sheets or other records. Routine payments at regular intervals work to the criminal’s advantage. However, the perpetrator may have to falsify time sheets and other documents for hourly phantom employees.
  3. Take the money. Converting paychecks or direct deposits to cash may require more subterfuge than direct cash payments. For example, an employee may set up a falsified bank account for direct deposits. Check cashing is riskier and may lead to apprehension. But once the crook pockets the cash, the fraud trail goes cold.

Red Flags

There are certain warning signs that a phantom employee is haunting your payroll system, such as:

  • Missing employee files,
  • Employees with overly vague (or no) job titles or descriptions,
  • Multiple employees with the same mailing address or bank accounts for payroll deposits,
  • Employees who list a post office box as their mailing address, and
  • High, unexplained employee turnover rate.

These warning signs can be cause for concern. However, you can discourage the creation of phantom employees by imposing strong internal controls.


Various measures can be taken to strengthen internal controls. For example, a business could simply stop paying employees in cash. Direct deposits aren’t foolproof, but they can cut down on fraud by eliminating paper paychecks and the possibility of alteration, forgery and most theft.

Managerial review can also reduce a business’s risk. For example, different supervisors might be assigned to approve payments to employees on a random basis. This makes it more difficult to hide a phantom employee. Supervisors should also be trained on how to scan the payroll records for red flags, such as suspicious names and multiple employees with the same mailing address.

Finally, the payroll system should be equipped with checks and balances. For instance, the head of a department should be required to verify any employees that are added or removed from the payroll system. Moreover, payroll records can be coordinated with personnel reviews. If an employee doesn’t show up for a review, it warrants further investigation.

Forensic Accounting Expertise

Phantom employees allow fraudsters to hide in plain sight. Over time, false wage payments can add up and become harder to detect. Please contact Cassady Schiller CPAs & Advisors to help assist with revealing these scams or any other fraudulent scams you may be concerned with.

What’s This New Pass-Through Deduction and Am I the Right Business Entity?

Patrick Rumpler, Senior Accountant, Mellott & Mellott, P.L.L

When the Tax Cuts and Jobs Act (TCJA) was signed in December 2017, no one completely understood how this law would change or impact their current situation. This law dramatically changes the tax landscape as much as any tax law has over the last 30 years. CPA’s and tax planners had a very hectic calendar year-end either meeting or calling most clients to discuss year-end tax strategies to ensure that they were taking the correct tax actions before the new law went into effect.  Since the law has been passed, there is still much uncertainty due to a lack of clarity from the Internal Revenue Service and Treasury Department.

One major change resulting from the TCJA is the new tax rate on C-Corporations. This is now a flat 21% whereas in the past there have been four tax brackets with the highest rate being 38%.

Another major change that will be affecting smaller businesses that are pass-through entities (Sole Proprietorships, Partnerships, and S-Corporations) is the 20% tax deduction that individuals can claim on Qualified Business Income. This past February, the AICPA sent a letter to both the Internal Revenue Service and the Treasury Department requesting additional information and transparency on this deduction. Currently, there are many grey areas surrounding the details and language on this topic.  While we are still waiting on their response (expected by July 2018), we do know the following facts:

Qualified Business Income (QBI) is net income received from a flow through trade or business that does not include W-2 wages from an S-Corporation or guaranteed payments from a Partnership. There are two types of QBI. One is specified service trade or business income (SSTB). This includes income individuals earned by working in the following fields: health, law, financial services and other industries where the business’ principal asset is the reputation or skill of one or more of its employees or owners.  Individuals in those industries will only be able to claim the 20% deduction if their taxable income is beneath the applicable thresholds as defined below. The second type of QBI is non-SSTB. This includes income earned by all other industries, including architects and engineers.

Looking at the general guidelines, if the taxpayer’s taxable income is less than $157,500 (single) and $315,000 (married) then the taxpayer would receive the full 20% deduction on qualified business income to the extent it exceeds the amount of taxable income (SSTB and non-SSTB). If the taxpayer’s taxable income is over $315,000 and lower than $415,000, then the deduction begins to get phased out (SSTB and non-SSTB).  It is taxpayers within that taxable income range, where this new tax change becomes complex and additional calculations are needed to determine the allowable deduction percentage. Calculations involve examining non-owner W-2 wages and property, plant, and equipment, which becomes too involved to discuss in this short article. Additional calculations also need to be performed for non-SSTB’s where taxable income exceeds $415,000. For SSTB’s, if the taxpayer’s taxable income is over $415,000 then they receive no deduction.  

With the introduction of the 20% tax deduction for pass-through entities and the 21% flat tax rate for C-Corporations, our firm and most other CPA firms have been deeply involved in more tax planning with our clients. A question being frequently asked is, “should we change our business entity type and how would the new corporate tax rate and pass-through deduction affect our taxes?” The answer to this question is unique to each business owner and taxpayer. Certainty, having a flat tax rate of 21% for C-Corporations may seem very attractive to business owners contemplating changing their entity type. Remember though, those who own shares in C-Corporations can be taxed twice. Once at the corporate level and then again when income is distributed to the individual shareholders. Depending on an individual’s financial position and tax rate, a taxpayer could be taxed at the highest tax rate of 37% for the individual tax. Depending on individual facts and circumstances it may make sense to switch to a C-Corporation simply based on tax rates and in other cases, remaining or switching to a pass-through entity could be the better option.

This is a dynamic time for all taxpayers and even more so with taxpayers that are business owners. The tax law has changed the rules of businesses significantly and choosing the entity type is more important now than it has been with the reduction in the C-Corporation tax rate and the new 20% deduction now available to many of the pass-through entities. Planning and discussions are necessary regarding entity type selection more now than ever before. If you are a business owner and have not done so yet, it probably makes a great deal of sense to meet with your financial advisor and your CPA, to ensure you are making the correct informed decision.

Planning a Business Succession: the Human Side

Adam Stypula, Senior Vice President & Chief Commercial Credit Officer, Park National Bank of Southwest Ohio & Northern Kentucky

You’ve done it! Your business is up and running. It’s reached profitability. It’s an established part of the community. Your blood, sweat and tears have made this venture. But you have to prepare for the day when you no longer run the show.

Succession planning is critical to a business lifespan, and it involves preparing for both good and bad scenarios.

Ideally, you leave on your terms: You sell it or you transfer it to a trusted employee, family member or friend. You also have to consider what happens in the circumstance of your untimely death, especially if there is no successor.

But let’s say there is a successor. The following steps, according to small business nonprofit association SCORE,which is supported by the U.S. Small Business Administration, are a good course to follow.

  1. Choose your successor.
    Consider employees who have the leadership qualities and skills to become owners. To remove bias, have the company’s board of directors or a search committee consider candidates. But don’t wait. Experts suggest identifying a successor 15 years before you plan to retire so you have time to oversee his or her progress.
  2. Develop a formal training plan.
    Have your successor train in every critical function of the company so he or she can become familiar with all aspects of the operation. Step back and let your successor have room to make decisions – and make mistakes – to learn and grow. This gives you a chance to see how your successor’s style fits with your broader business goals.
  3. Establish a timetable.
    Training your successor and giving him or her control should be mapped out. And a timeline motivates your successor to finish their training successfully and helps clarify their day-to-day role as you transfer operations. Successful transitions occur when you, your successor, your management team and even your employees know who is in charge of making decisions. You don’t want to derail your successor’s progress, so resist the urge to overrule the person regularly.
  4. Prepare yourself for retirement.
    Just as you map out your successor’s transition, do the same for yourself. Identify what you’ll be doing as he or she takes over. In this way you can stay energized about your business while also involving yourself in other non-business-related activities.
  5. Install your successor.
    You’re leaving on your terms and you’ve laid the groundwork for your replacement’s success. You’ve left your mark by establishing the company’s culture, now it’s your successor’s turn to achieve or fail on his or her own.

To ensure a successor, make sure you create management depth in the company. As the owner, you don’t want an incapacitation or your unexpected death to sink what you worked hard to build.

But what if your business is a one-person operation or successor potentials are sparse or non-existent? Your financial institution, especially if you have loans tied to the business, might suggest seeking key person life insurance. In event of your death, the policy will pay off the liabilities, and you can even structure the insurance to take care of your family.

Please Remain Seated and Fasten Your Seatbelts

Andy Bruns, John D. Dovich & Associates, LLC

“Return to your seat, fasten your seatbelt, and remain seated until the captain turns off the seatbelt sign.”

Given recent market volatility, we can all take advice from this familiar in-flight announcement.  Market volatility and air turbulence are very much similar, and just like when encountering air turbulence, if you remain seated and calm during periods of market volatility, you will arrive at your destination.

Encountering turbulence is a fact of flying.  It’s going to happen and most passengers can endure it.  Most injuries caused by turbulence are not due to catastrophic failure but by passengers not heeding the pilot’s warning.  Not only are aircraft engineered to withstand more than the normal amounts of turbulence, but, pilots are able to mitigate the impact of turbulence by altering their course and slowing their airspeed.

Now how does this apply to markets?  Like turbulence, market volatility occurs in pockets.  During a flight there might be some bumps, but for the most part the ride is either consistently smooth or bumpy.  The same could be said about capital markets.  For this example, let’s look at market data covering May 1, 2008 to April 30, 2018 and let’s define “volatility” as a movement in a portfolio’s value greater than 1% (either positive or negative) from the previous day’s closing price.

If you had invested $1,000 in the US stock market on May 1, 1998, as represented by the S&P 500 Index, and kept it invested for the duration, you would have a portfolio value of about $3,469 on April 30, 2018.   That’s approximately a return of 6.4% annually.

Investors can take measures to lessen the impacts of volatility just as a pilot might adjust the plane’s airspeed and altitude to avoid or mitigate pockets of turbulence.   If you had invested that same $1,000 on May 1, 1998 into a portfolio that was 65% stock and 35% bond, using the S&P 500 Index and the Bloomberg Barclays US Aggregate Index as the respective stock and bond proxies, the daily portfolio movements of 1% or greater were halved.  This assumes that the portfolio is rebalanced annually to its target allocation.

To leave you with some final thoughts at the departure gate, volatility is part of the cost of investing just like turbulence is part of flying.  Your portfolio is more likely to weather market volatility and come out OK if you remain seated with your seat belt securely fastened.  Injuries happen if you ignore the captain and start roaming around the cabin during periods of volatility.

As an investor, you need to understand how much risk you are willing to take and the volatility you can handle. On my last check of Google maps though, it takes 5 hours and 50 minutes to fly from New York to Los Angeles and 43 hours to drive that same distance.  In my opinion, weathering some turbulence is worth it.