Regardless of your business structure (sole trader or limited company) employing a spouse/ civil partner (or any other family member) can be one of the more efficient ways of reducing tax for your business. Such employment can take advantage of lower tax rates and personal allowances that may be available to your family member. If they are a shareholder of the company and also employed, a mixture of salary/bonuses, benefits, and dividends, could be paid thereby reducing the overall tax bill.
The work undertaken by the family member must be ‘wholly and exclusively’ for the business. The National Minimum Wage does not apply to family members working in the family business if they live in the same household so technically you could pay whatever you wanted. However, the payment must be commercially viable, the amount realistic and not excessive for the work undertaken. If no work or little work is undertaken, HMRC could refuse the company a tax deduction and treat the payment as a distribution to the director. By appointing the family member as a director, a small salary could be paid, even if little work is undertaken.
Whether the family member lacks sufficient NI contributions towards their state pension (or is not liable to NI payments) may also have a bearing on the amount to pay. For a year to qualify for state pension purposes payment needs to be of 52 weeks x Lower Earnings Limit of £533 a month (£6,396 a year).
Should HMRC question the amount paid and decide that the payment is ‘excessive’, then the amount will be disallowed in computing the taxable profits. If the employment is in a company not only will the amount be disallowed but if the family member is also a shareholder, that amount may be treated as a distribution, taxed at the dividend tax rates.
The salary should preferably be paid into the family member’s personal bank account and recorded in the accounts as payment just like any other employee. Payments for wages to children must follow similar principles and caution is needed if employing minors to ensure that working regulations are not breached. It would also be preferable for the family member to be included on the payroll.
Apart from the payment amount being similar for comparable work outside of the business, when working out the amount to pay, consideration will be needed to ensure that the tax saving achieved is not counteracted by a higher tax bill for the family member. Other factors to consider include whether:
- the family member has another job or income and if so, how much personal allowance remains to be allocated against the salary
- the transferable marriage allowance is available
- the employee is over state pension age as no NIC contributions are payable or under 21 years as no employer’s NIC is payable
- the Employment Allowance (EA) can be claimed (enabling eligible employers to reduce their annual NIC liability by up to £5,000). Whether or not the EA can be claimed will also have a bearing on the optimum salary payable.
As ever in tax – evidence is important. Bank statements and recording payments in the business accounts would provide evidence of what had been paid, which could be linked to the recorded hours worked.