Being able to pay family members from your business can be really useful. It can help with income splitting, making use of unused tax allowances, and keeping things in the family.
But what do you need to do to get it right? And what might happen if you get it wrong?
Get the basics in place first
Don’t take shortcuts just because it’s a family member. HMRC expects you to treat them like any other employee, and that means:
- Operating a proper PAYE payroll
- Issuing payslips
- Having a job description and employment contract
- Paying their net wages into their own bank account
- Enrolling them in a workplace pension if they qualify
If you’re paying family members but skipping these steps, you’re already on shaky ground.
Can you legally pay your spouse or children?
Yes…but there’s a big “but.”
The work they do needs to be real. If they aren’t actually doing anything for their money, or just doing trivial tasks, the payment is unlikely to be tax-deductible for the business.
You can only claim a tax deduction for costs that are genuine business expenses, or, to use a bit of jargon, costs incurred wholly and exclusively for the purposes of the trade. Paying your teenager £12,000 a year to “help out occasionally” doesn’t meet that test.
If in doubt, you need to make sure you are ticking three boxes:
- The work needs to be substantive.
- The pay needs to reflect what you’d pay someone else to do the same job.
- You need to be able to evidence it.
What about children specifically?
If your children are under 13, employing them may actually be illegal, and no tax deduction will be available even if the work is genuine.
For children aged 13 to 16, there’s local authority legislation that restricts when and how long they can work. You’ll need to check the rules in your area before paying family members who are still at school.
What happens if you get it wrong?
HMRC may challenge payments to family members as a diversion of the owner’s income. The usual approach is to:
- Deny a corporation tax deduction where the payments aren’t wholly and exclusively for the trade.
- Treat the payments as the owner’s remuneration in substance (meaning you get taxed on them personally).
In some cases, HMRC may also invoke specific anti-avoidance rules, including the settlements legislation.
What is the settlements legislation?
If you really want to, you can go and read Section 629 of the Income Tax Act. But here’s the short version:
If a child’s income is effectively a gift from a parent – rather than genuine payment for work – it gets taxed on the parent, not the child. This applies to children under 18, and kicks in if the income exceeds £100 per year.
So if you’re paying family members who are minors, you need to be especially careful. The settlement’s rules are there precisely to stop parents shifting income to children who aren’t really earning it.
The bottom line
Paying family members from your business is absolutely allowed, and can be tax-efficient when done properly. But the key words are “done properly.” Make sure the work is real, the pay is reasonable, and the paperwork is in place.
If in doubt, get advice before you start – not after HMRC starts asking questions!
Want help making sure you’re doing this right? Get in touch; we’ll help you set things up properly. |
