Wages to Family Members
Many of our clients employ their spouse or children to help them with their administrative duties at home. This article looks at the reasons for doing this and some of the pitfalls that must be avoided. It concentrates on the position of a sole trader.
Provided you bear in mind the points below, the cost of wages paid to them will be an allowable deduction from the profits of the business, so it makes sense to employ them if:
You pay tax on the profits of the business and they do not have any other taxable income, or:
You pay tax at the 40% or 45% rate and they only pay at 20%.
This is the most essential point – you must not charge wages to the business unless there is a real commercial justification for doing so. The work they do must justify the pay they get.
The tax inspector may well ask questions about wages paid to family members, so it is important to be clear about the hours worked, the rate per hour and the duties involved.
If your spouse or children have no other employment income, then you can pay them up to £5,876 per year without having to deduct any tax or NIC or even needing to run a payroll, however, you will need to run a monthly payroll if the amount is above £5,876.
If your spouse has another paid job, it is unlikely to be worthwhile employing them because you will have to deduct basic rate tax from all their wages, no matter how small.
The rule of thumb, therefore, is that it is only tax efficient for a sole trader to pay his spouse a wage if:
The spouse has no other income of any kind, or;
The trader is paying tax at the 40% or 45% rate and the spouse is a basic rate taxpayer and has no other employment income (“employment income” includes a pension).
It is not enough simply to make an entry in the books for the spouse’s wages – they must actually be paid, preferably by cheque or direct debit into their own personal bank account, so that there is an audit trail if the HMRC come looking for it. However, please note that the wages should not be paid into a joint account, as it could be argued that the trader has not really paid them as he still has access to the money. It is suggested that you pay them weekly or monthly.
Dr Ali does some medical reports from his home. His 18 year old son helps him out for five hours a week at £10.00 per hour, earning a total of £50 per week. This amount equates to £2,400 a year, assuming four weeks’ break.
Dr Ali can offset the £2,400 he pays his son against his profits for income tax purposes. Provided his son has no other income, he does not have to pay any tax on the money because he falls well below the annual tax-free personal allowance (£11,500 in 2017/18).
If Dr Ali had done the work himself and not employed his son, that £2,400 would remain part of his taxable profits for the year and he would be liable to pay tax on it. If he was liable to income tax at the higher rate of income tax of 40%, the household would have received only £1,440 (£2,400 less 40%) instead of the full £2,400. National Insurance contributions may reduce the household income even further.