Running your own business often means juggling several different roles. One effective way to get extra support is by employing a family member.
Whether you operate as a sole trader, partnership or limited company, employing a spouse, civil partner or other relative can be a practical and tax-effective decision. However, you need to set up the arrangement correctly and be able to justify the payments you make.
Employing a family member in your business
Overview - Pay and Fair Remuneration
We have previously looked at gifting shares to your family, when they work in your business, we'll now focus on those tax issues when you pay them a salary as an employee. But what happens when a family member works in your business and you pay them a salary?
When employing a family member in your business, you normally need to comply with the National Minimum Wage (NMW) or the National Living Wage (NLW)rules where they apply. Furthermore, HMRC may challenge wages paid to family members if the cost is not incurred wholly and exclusively or the purposes of the business.
This means that wages should reflect the actual value of the work they perform. The amount should also be reasonable when considered under the ‘arm’s length principle’.
Justifying a higher than average wage to a family member
You may sometimes have good reasons for paying a family member more than you would pay an unrelated employee.
For example, you may rely more heavily on their flexibility, diligence or trustworthiness. They may also work longer or less predictable hours. In addition, they might regularly discuss business matters with you outside normal working hours.
These factors could help justify a higher salary. However, you should document the reasons for the level of pay.
Planning points
The points you need to consider will depend on which family member you employ and the role they perform.
Spouse/Civil partner working in the business
Before deciding to employ your spouse or civil partner, consider whether employment is the most appropriate arrangement. For example, if you operate as a partnership, they could potentially become a business partner instead.
Make sure the work they carry out is genuine and clearly defined. A written employment contract can help demonstrate this. It should set out their duties, working hours and pay.
You should also operate PAYE and National Insurance correctly where required. Keeping proper payroll and employment records helps demonstrate that the arrangement is genuine.
A formal employment contract can therefore provide useful evidence if HMRC questions the arrangement. Different rules can apply where your spouse or civil partner is a company director. In particular, directors may fall outside the NMW/NLW rules in certain circumstances.
ou should pay wages directly to the family member and keep a clear audit trail of the payments. Pay them regularly in the same way you would any other employee. You should also keep records showing the work they actually performed.
You can include additional benefits as part of their remuneration package where appropriate. These could include employer pension contributions or a mobile phone.
Employing your children and younger family members
The same principles apply when you employ children or younger relatives. Their wages should reflect the work they actually perform. HMRC could disallow excessive payments when calculating your taxable business profits.
If your children are still of compulsory school age, additional employment rules may apply. These can restrict the type of work they can perform and the number of hours they can work.
It is particularly important that your children genuinely carry out the work you pay them for. Simply paying a child a salary without them performing genuine duties is unlikely to produce the intended tax result.
You should therefore keep evidence of the work they perform. Their employment must also comply with the relevant employment law and PAYE requirements.
You may also be able to provide benefits as part of their employment package. For example, a smartphone could be appropriate if they genuinely need it to perform their role.
However, the benefit should have a genuine business purpose. You should consider whether you would provide the same benefit to an unrelated employee doing a similar job
As with salary, you should provide employment benefits on a commercial, arm's length basis.
Summary
When employing a family member in your business, good records and compliance with the relevant tax and employment rules are essential.
Employing relatives can provide genuine benefits. You gain support from someone you trust, while the arrangement may also offer tax efficiencies for the family.
However, you need to treat the arrangement as genuine employment. Make sure the salary reflects the work performed. Keep contracts and payroll records where appropriate, and retain evidence of the work carried out.
Finally, review the arrangement regularly. Roles, working hours and responsibilities can change over time. Regular reviews help ensure the level of pay remains reasonable and the arrangement continues to work for both your business and your family.
For more useful information, check out our Ebooks here.
And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at [email protected].
Alternatively, please feel free to complete our Business Questionnaire here.