Why Employ your Spouse or Child?
Provided you bear the points below in mind, 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
You pay tax at the 40% rate and they only pay at 22%
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 – though as we shall see, they probably need not do much work to justify the amounts I suggest they should be paid.
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.
National Minimum Wage
The NMW (currently £5.35p per hour for those over 22 years old) does not apply to members of a family working in the family business if they live in the same household, so you are free to work out the most tax efficient rate of pay for your spouse or child.
This depends on a number of factors:
PAYE – if your spouse (for the rest of this article, I shall use the word spouse, but the advice applies to other members of the family as well) has no other employment income then you can pay them up to £100 per week without having to deduct any tax or NIC – but make sure they sign a P46 to certify they have no other employment income.
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.
If you are self employed, even if you pay tax on your profits at 41% (this includes your Class 4 NIC at 1%) it is hardly worthwhile paying your spouse wages that produce a charge on them at the basic rate of tax:
Wages Paid per £1,000
Tax Saved on Profits
Tax on profits saved
Employers NIC 12.8%
Employee’s NIC 11%
Income tax 22%
Of course, if the trader is only paying basic rate tax on the profits the position is even worse as the saving will only be £338 (tax £248 plus Class 4 NIC of £90) but the costs will be the same, so in this case the family actually loses money.
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,
The trader is paying tax at the 40% rate, and the spouse is a basic rate taxpayer and has no other employment income (“employment income” includes a pension)
In both cases, there will be little or no tax saving if the spouse is paid more than £100 per week
It is not enough simply to make an entry in the books for the spouse’s wages – they must actually be paid to them, preferably by cheque or direct debit, so that there is an audit trail if the inspector comes looking for it. 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.
If wages are paid in cash it is good practice to get the spouse to sign a receipt.
In theory, if the wages are included in the accounts and are paid within nine months of the accounts year end, they are an allowable deduction but I strongly recommend you do not rely on this – pay them weekly or monthly.
Although you do not have to deduct PAYE if the spouse has signed a P46 and their wages are £100 per week, you do have to make an annual PAYE return if the wages are more than £87 per week. A rate of pay between £87 and £100 has the added merit of enabling the spouse to qualify for State Benefits.
Be careful about employing children under 16 – there is legislation restricting this which is beyond the scope of this article.