EMPLOYING YOUR FAMILY

As a general rule, you can save income tax if income can be diverted from you to other members of your family to make use of their annual personal allowances and benefit from their lower marginal rates of tax.

Warning! If you employ family members, their salaries will tend to come under scrutiny during the course of an enquiry by HMRC into your company’s accounts. HMRC will be looking to see whether the salaries exceed a commercial rate for the work performed. Where the amount paid clearly exceeds the commercial rate, HMRC will seek to disallow the excess on the grounds that it has not been incurred wholly and exclusively for the purposes of the company’s trade. An identical rule applies to unincorporated businesses.

The “wholly and exclusively” point was considered in the First-tier Tribunal (FTT) case of McAdam v HMRC 2017 where a plumber claimed a deduction for £90 per week to his wife for writing up his books, taking phone calls, processing orders, etc. HMRC accepted that the taxpayer’s wife had done some work, but calculated that an appropriate wage would be £1,344 per annum (about £26 per week), at an hourly rate of £8.

The FTT agreed with HMRC and refused the deduction. It said the payment was excessive compared to the going rate for the type of work, plus the plumber’s business records were poor and there was nothing really to show how much work his spouse did or that she was employed at all.

To avoid this trap, make it clear what the family member is doing. To help, use a Family Member’s Job Description to set out the duties they will carry out.

Just using the job description doesn’t guarantee that you can deduct any salary payments. You will also need to keep records to demonstrate the work done by your family member. This could be achieved by getting them to complete a timesheet if an hourly rate is being paid.

Ensure the amounts paid are equivalent to what you would have to pay for a third party to perform the same duties. For example, don’t be tempted to pay your son £15,000 for cleaning the windows once a month. If you are employing someone, then you should ensure that you are at least paying the national minimum wage or national living wage rates, depending on their age.

If HMRC challenges the remuneration for a family member, try to get it to agree an “allowable” amount so that you don’t lose the entire tax deduction.

Provided the “excess” element is formally waived and paid back to the company, HMRC will generally restrict the income tax charge to the tax allowable part of the remuneration.

 

When is it beneficial to employ your spouse?

Each spouse (or unmarried partner) has their own personal allowance and personal basic rate tax bands. So it’s generally beneficial to pay them a salary if the following conditions are met:

• the salary will be taxable at a lower rate of tax than it would be if it was paid to you
• the income tax saving is not less than the additional NI liability
• your company is able to obtain a tax deduction for the salary, i.e. it is not excessive.

Note. Civil partners have the same legal status as spouses for tax purposes. References to “spouse” should be read as “spouse or civil partner”.

You should actually pay the salary amounts to your spouse rather than the salary being merely an accounting entry. When paying them, it’s preferable to pay the salary into a bank account in your spouse’s sole name rather than a joint account. In Moshi v Kelly 1952, tax relief for a wife’s wages was denied as they were charged to the owner’s own drawings account.

Any amounts paid to your spouse must not be lower than the national living wage (NLW). Therefore, the amount you can pay your spouse (providing they are 21 or over) must not be less than £12.71 per hour for the 2026/27 tax year.

If you make your spouse a director, then the NLW may not apply providing they don’t have an employment contract and are effectively receiving a salary for their role as an office holder.

 

What’s the optimal salary to pay your spouse?

You need to weigh up the income tax savings against the additional NI costs. For 2026/27, your spouse can earn up to £242 per week without paying any employees’ NI. Above this level they’ll pay 8% employees’ NI on earnings between £242 and £967 per week (£12,570 to £50,270 on an annual basis for 2026/27) and 2% on earnings above £967 per week. For 2026/27, the company will pay 15% employers’ NI on earnings over £97 per week (£5,000 on an annual basis) - although, depending on the number of other employees the company has, it may be possible to offset the employers’ NI cost using the £10,500 NI employment allowance.

Assuming your spouse has no other income, for the 2026/27 tax year you can pay them a salary of £1,048 a month (£12,570 a year) without them incurring any income tax or NI liability. If the employment allowance has been fully utilised by the company’s other employees, the company will need to pay employers’ NI of £1,136 (15% of (£12,570 - £5,000)) but this cost will be more than offset by the 25% (or 19% if taxable profits are below £50,000) corporation tax saving. Just make sure that the amount paid is commercially justifiable for the actual work done.

If you can justify a wage of at least £129 per week for the whole of 2026/27, your spouse can receive free NI credits to build up their entitlement to the new state pension without them actually having to pay any NI.

If your spouse is a director then, due to the legal obligations and responsibilities that a directorship involves, this position alone should justify a reasonable level of remuneration.

Can your spouse be a self-employed contractor instead?

Rather than putting your spouse on the company’s payroll, they could invoice the company for their services. As a self-employed person, they would need to register for self-employment with HMRC and complete a self-assessment tax return. Assuming your spouse has no other income, for 2026/27 they would pay:

• income tax on any profits over £12,570
• Class 4 NI at 6% on their annual profits between £12,570 and £50,270 - 2% less than if they were employed and the company doesn’t have to pay the 15% employers’ NI
• Class 4 NI at 2% on their profits over £50,270.

Note. Since 6 April 2024, self-employed taxpayers no longer need to pay Class 2 NI. However, your spouse may choose to pay Class 2 NI if they want to protect their entitlement to the state pension, but this will only be an issue if their self-employed earnings are below the small profits threshold of £7,105. In this case, they can make voluntary Class 2 contributions of £3.65 a week which are cheaper than making voluntary Class 3 contributions at £18.40 per week. If their profits are between £7,105 and £12,570, there’s no Class 2 NI to pay but your spouse would receive a Class 2 NI credit.

As a self-employed contractor, they would also be able to offset various expenses against income such as mileage, stationery, use of home as office, etc.

Warning! In theory, whether your family member is employed or self-employed isn’t actually a choice. Because being self-employed means less NI, HMRC will want to see that a person is genuinely self-employed. So if you go down this route, you will need to have evidence that your family member is effectively running their own business. Factors to consider including in a self-employed contract are:

• paying them a fixed price for a particular piece of work/function rather than an hourly rate
• letting your family member decide when and how they do the work
• requiring them to use their own equipment, e.g. computer and mobile phone
• stating in the contract that you are not obliged to provide them with work and they are not obliged to accept the work you offer
• requiring them to submit invoices to you before payment is made.

 

Is it more tax efficient for them to be an employee or self-employed?

Since 6 April 2023 when the annual Class 2 NI threshold was increased to bring it in line with the employees’ NI threshold (i.e. £12,570 for 2023/24 to 2026/27), it is more tax efficient for a spouse to be self-employed rather than employed by the company unless the company has an annual employers’ NI bill of under £10,500 (when taking into account the spouse’s salary) and can take advantage of the employment allowance which has increased significantly to £10,500 for 2026/27.

 

Your spouse is not a shareholder in the company

[Example

Let’s say you want to pay your spouse, who has no other income, £15,000 per year. If you pay this as a salary, they will pay £194 NI and the company will pay £1,500 NI (assuming this can’t be offset by the employment allowance). Assuming a 25% corporation tax rate, the after-tax cost to the company will be £12,375 and your spouse will take home £14,320 after income tax at the basic rate on £15,000 - £12,570.

If your spouse were self-employed, the NI paid would be £146 (£6% x £2,430). So your spouse would have £14,368 after income tax and NI and the after-tax cost to the company would be £11,250. A net tax/NI saving overall of £1,173.

If your company can make use of the employment allowance to offset the employers’ NI on your spouse’s salary then the company will save the employers’ NI bill of £1,500 and, therefore, a salary would be preferable to self-employed earnings.

 

Your spouse is a shareholder in the company

This situation is a little more complicated as you have the option of paying your spouse dividends rather than a salary and there’s no NI on dividends. 

 

Can your company pay your children a salary?

Your children could work for your company at weekends or in their school/university holidays. There’s no reason you can’t pay your son or daughter to do some filing, clean the company vehicles or even help with IT. With some creative thinking we’re sure you could find 101 tasks.

You can create a role for your son or daughter without troubling HMRC as long it serves a function for your company. What’s more, not only will your company get a tax deduction for the cost of paying your youngster, it’s tax efficient for you.

 

Why is it more tax efficient?

If your company pays your children, you’ll have to find less out of your own pocket to support them. This can make a big difference; where you pay them, the money will originate from salary or other income on which you’ve paid tax and NI, but where your company pays them, these deductions won’t apply.

Example

You pay your two youngsters pocket money of £10 each per week. That’s £1,040 per year. As a 40% taxpayer this takes £1,793 of your salary (£1,793 less tax at 40% of £717 and NI at 2% of £36). If, instead, your company pays, the cost to you directly will be nil. Plus, because their pay is tax deductible, the cost to your company is just £780 (assuming a 25% company tax rate). That’s less than half the cost of the pocket money, and what’s more you’ve got a few chores done around the office.

 

How many hours a week can your children work?

You need to make sure your company is complying with the appropriate laws for employing school-age children including the number of hours they work.

With some limited exceptions for specific jobs, e.g. acting or modelling, it’s generally illegal to employ children under 13. So this will rule out your company employing any of your pre-teenage children.

The position for 13 year olds depends on local by-laws. Some areas allow them to do limited work, some allow them to do the same work as a 14 year old and some do not allow them to work at all.

Children under school leaving age can do light work, such as office work, as long as it doesn’t hinder their education or affect their health and safety. Certain types of work, e.g. in factories or industrial units, are prohibited and any business employing children under school leaving age must obtain a child employment permit from the local council.

Subject to these points, school-age children can work up to two hours most days. On Saturdays and weekdays during school holidays this is increased to eight hours (five hours if under 15). Working hours must fall between 7.00am and 7.00pm and are subject to an overall limit of twelve hours per week during term time or 35 hours during school holidays (25 hours if under 15). In addition, the child must also have at least two weeks of uninterrupted holiday each calendar year.

Children over compulsory school age but under 18 can generally work 40 hours a week and once your children are 18 they are subject to the same employment rules as everyone else.

If you want to employ your school-age children, contact your local council’s education department to check what the requirements are and whether you need to apply for a child employment permit.

 

What’s the optimal amount to pay your child?

Each child has their own tax-free personal allowance of £12,570 (for 2026/27) to use. Assuming they have no other income, this means they can a receive an annual salary from your company of up to £12,570 without paying any tax.

If they’re under 16, there will also be no NI to pay and your company won’t have to pay NI for them either. As children under 16 don’t pay NI, you don’t need to include them on your payroll unless their total income is over their personal allowance.

If they’re aged 16 to 20, they will start to pay employees’ NI of 8% on wages over £242 per week but your company won’t have to pay any employers’ NI providing they don’t earn more than £967 a week. Although they will be paying 8% NI, your company will be saving 25% corporation tax (19% if taxable profits are under £50,000) on their wages, so it would still make sense to pay them up to their £12,570 personal allowance.

Warning! You need to establish a commercial justification for the payment. Based on a twelve-hour week, a £12,570 salary equates to an hourly rate of just over £20. If the level of pay is challenged by HMRC, you should be prepared to demonstrate that the rate you’ve paid is no more than your company would need to pay a non-family member for the type of work your child does for it.

The national minimum wage (NMW) rules must be adhered to for children aged 16 (and at least school leaving age) to 20. The NMW rates for 2026/27 can be found here.

Assuming you can justify a rate of £5 per hour, taking into account the allowable working hours, the maximum annual salary that your child could earn would be approximately:

• 13 and 14 year olds: £3,715
• 15 and 16 year olds (below school leaving age): £4,265
• over compulsory school leaving age but under 18: £16,640 (the NMW is £8 for under 18s above school leaving age so you’d have to pay this hourly rate).

HMRC will want to see that the wage is actually paid to the children so you should consider setting up a separate bank account for them, if they don’t have one already, and getting the company to pay their wages directly into that.

 

Paying dividends to family members

If your spouse doesn’t do any work for the company, you won’t be able to justify paying them a salary. But if your spouse owns some shares in your company, they can receive dividend income instead. This can be a highly tax-efficient mechanism for extracting income from your company.

 

How much could your spouse receive in dividends?

For 2026/27, it’s possible to pay a dividend of £500 tax free regardless of the recipient’s marginal rate of tax. So if your spouse is a shareholder in the company and has no other dividend income, profits of £500 can be extracted tax free by making use of their dividend allowance.

If your spouse has no other income, it’s possible to pay a further tax-free dividend to use up their personal allowance (£12,570 for 2026/27). This means a non-tax paying spouse could take a total tax-free dividend of £13,070, i.e. an amount equal to their personal allowance plus their dividend allowance.

If you can justify paying your spouse a small salary, rather than taking the £13,070 as tax-free dividends, it may be preferable to pay a salary up to the NI primary threshold (£1,048 a month for 2026/27) to enable your spouse to build up entitlement to the state pension and other contributory benefits.

Once the personal and dividend allowances have been used up, further dividends are taxed at 10.75% until the basic rate limit is reached. For 2026/27, the basic rate limit is £37,700 but the £500 dividend allowance counts towards this.

If you have already used your basic rate band and wish to pay further dividends, it’s better to pay them to your spouse if they will be taxed at 10.75%, rather than to pay them to yourself and suffer a tax charge of 35.75%. This will generate a tax saving of 25% of the dividend.

 

Example

Acom Ltd has two shareholders - Mike who owns 100 A shares and Sonja who owns 100 B shares. Sonja has no other income.

In 2026/27 Mike takes a salary of £12,570 and dividends of £37,700, of which the first £500 are tax free and the remainder (£37,200) are taxed at 10.75%, generating a tax bill of £3,999. He wants to extract a further £30,000 as dividends.

By paying the dividend in respect of the B shares to Sonja, the first £12,570 will be covered by her personal allowance and the next £500 by her dividend nil rate band. The remaining £16,930 will be taxed at 10.75%, generating a tax bill of £1,820.

If the £30,000 dividend had been paid to Mike in respect of the A shares, it would have been taxed at 35.75%, generating a tax bill of £10,725.

 

How does your spouse become entitled to dividends?

Payment of dividends to your spouse can be achieved by: 

• the creation of a new class of shares; or
• you transferring some of your existing shareholding to them.

Depending on the facts, HMRC may contend that such arrangements constitute a “settlement”. This would negate the tax advantage as the dividends would then be taxed as your income at your highest rate of tax. However, as long as your spouse is provided with fully-fledged ordinary shares (with the normal full range of rights such as the right to vote and to receive a surplus on winding up), HMRC is unlikely to challenge it now following the highly publicised Arctic Systems case (more formally known as Garnett v Jones 2007) when HMRC’s appeal to tax Geoff Jones on dividends paid to his wife, Diana, was rejected.

It’s prudent to pay dividends to a spouse into their own separate bank account as opposed to a joint account to demonstrate that they have an absolute right to the income.

It’s also advisable to make your spouse a director to demonstrate that they have a certain level of responsibility in the company.

 

Using alphabet shares

If your spouse has the same class of share as you then dividends will need to be paid in the proportion of each of your shareholdings. For example, if you have 51 ordinary shares and your spouse has 49 ordinary shares, voting a £100 dividend on each ordinary share would mean you’d receive a dividend of £5,100 and your spouse, £4,900.

Instead, before transferring any shares to your spouse, you could reclassify the ordinary shares into “Ordinary A” and “Ordinary B” shares. The classes should all rank “pari passu” with each other (this means that they have an equal footing; for example the same voting rights and rights to proceeds on winding up). However, they will have different rights to dividends to allow you to vote a different dividend for each class of share. You could then keep the “A” shares and transfer the “B” shares to your spouse.

Example

Edward has ten ordinary shares in Acom Ltd. He would like to give five shares to his wife, Veronica, so that she can also receive some dividends. Edward completes the necessary paperwork to reclassify his shares as five Ordinary A shares and five Ordinary B shares and he then transfers the Ordinary B shares to Veronica. Acom Ltd has a total dividend pot of £40,000. As Edward receives pension income as well as his salary from the company, it’s decided that the A shares should receive a dividend of £2,000 per share so £10,000 in total (which keeps Edward in the basic rate band) and the B shares receive a £6,000 per share dividend so £30,000 in total.

You need to pass an ordinary resolution to reclassify shares. You also need to inform Companies House of the share class changes on Forms SH08 and SH10. As it’s important to get the paperwork spot on, it’s probably best to involve your accountant with this.