In the UK it is reckoned that more than 60 per cent of UK businesses are family owned. Whilst it has its downsides over the sunday dinner table, employing family members means that it should be possible to take advantage of lower tax rates and personal allowances that may be available to spouses, civil partners, and/or children. In turn, this arrangement can help reduce the household’s overall tax bill.
A few rules, however, do need to be kept in mind when taking on family members:
- The relative has to be hired to do real work at a proper commercial rate. HMRC are likely to query payments of £50 per hour to a 10 year old who is ‘employed’ to take telephone messages.
- Local authorities have rules on children working. The rules do not usually apply to a few hours working at home, say, stuffing envelopes. However, if you want to employ a child under 16 in other circumstances, you will need to check with the council first.
- Family members (over 16 years of age) who earn more than the National Insurance contributions (NIC) primary threshold of £146 (for 2012/13) in any week are liable for NICs. In addition, the employer will also have to pay NICs on their behalf.
- The money does actually have to be paid to the employee. HMRC may ask to see evidence that the money has gone from the business to the family member concerned. It is important, therefore, o keep proper records of all payments made.
Example
Hugh has a carpet cleaning business and his 16 year old daughter Fiona helps him out for five hours a week at £7.00 per hour, earning a total of £35 per week. This amount equates to £1,750 a year, allowing for school holidays and some overtime. Hugh can offset the £1,750 he pays Fiona against his profits for income tax purposes. Provided Fiona has no other income, he doesn’t have to pay any tax on the money because he falls well below the annual tax-free personal allowance (£8,105 in 2012/13). If Hugh had done the work himself and not employed his daughter, that £1,750 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 £1,050 (£1,750 less 40 per cent) instead of the full £1,750.
Employing a spouse or partner can be particularly tax-efficient where trading is undertaken through a limited company. If a spouse or civil partner is a shareholder in the company, and is also employed in it, they can be paid a mixture of salary/bonuses, benefits, and dividends, thereby reducing everyone’s overall tax bill quite considerably. If Hugh also wants to (and has the means to) take £50,000 a year from his limited company, regardless of whether the amount is paid as salary or dividends, a 40 per cent tax bill will apply to the top slice of his income.
Contrast this with George and Mildred who own 1 per cent and 99 per cent respectively of the shares in a business. They do not have income from other sources. They wish to (and have the means to) take £50,000 a year from the business. If George receives say, £30,000 in salary, he will only pay income tax at the basic rate along with NICs. The remaining £20,000 can be paid out as dividends. Mildred receives £19,800 (in relation to her 99% shareholding), whilst George receives only £200. Mildred’s income is well within the basic rate threshold so she doesn’t have to pay any additional tax on the dividend received. George’s share of the dividend won’t push him into the 40% bracket either. An alternative would be to pay Mildred £20,000 in salary. She would have to pay total tax and NICs of £4,038 (in 2011/12). Although this method leads to more tax being paid than going the dividend route, it still works out a good few thousand pounds less than paying the £50,000 salary straight to George.
Summary
Employing family members in a family-run business often means that it is possible to structure things so as to take advantage of lower tax rates and personal allowances, which in turn will reduce the household’s overall tax bill. A careful eye needs to be kept on the specifics of the relevant tax legislation and as always, taxpayers need to look at the wider picture and never do anything for the sole purpose of avoiding tax.
Contact our tax team on 08450507613 to see what savings there are for you.
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