Employing family members: Tax implications and avoiding HMRC issues

Just last week, a local shop owner came to me with a question that many small business owners ask, ‘Michelle, can I put my husband on the payroll to save tax?’ It’s a great question, and the answer is yes – with some important caveats!

The tax benefits of employing family

Let’s start with the good news. Employing your spouse, children, or parents can create genuine tax savings –

• Using family members’ tax-free personal allowances (currently £12,570)
• Keeping more money within the family unit
• Reducing your company’s corporation tax bill through legitimate salary expenses
• Creating opportunities for pension planning

For example, a local restaurant owner recently saved over £3,000 by employing her husband part-time to handle the bookkeeping instead of taking all the income herself. The arrangement reduced her higher-rate tax burden while using his unused personal allowance – a win-win situation.

The employment must be genuine

HMRC isn’t opposed to family employment, but they do insist on one crucial requirement: the work must be genuine, necessary, and actually performed.

This means that

• The family member must actually do the work they’re being paid for
• The payment should be reasonable for the work done
• You need proper documentation (just as you would for any employee)
• The money must actually be paid to them (not just on paper)

A Dartford consultant who employed his wife for ‘administrative support’ ran into trouble when it became clear she wasn’t doing any actual work for the business. HMRC reclassified the payments as dividends, resulting in additional tax and penalties. Don’t let this happen to you!

Which family members should you consider employing?

Spouses and Civil Partners

Employing your spouse can be particularly tax-efficient, especially if they’re not using their full personal allowance or are in a lower tax bracket than you. Many of our clients find this arrangement works well when their partner handles bookkeeping, administration, or marketing.

Children

Children aged 14+ can legitimately work in the business during holidays or part-time alongside studies. Remember that normal employment law still applies, including National Minimum Wage requirements for those aged 16 and over. You can find more information on the HMRC website about Child Employment.

Parents or Other Relatives

Parents approaching retirement might welcome extra income that also builds up their National Insurance contributions. You can check your NI record online. Other family members might bring valuable skills to your business while creating tax-planning opportunities.

Creating Proper Documentation

If there’s one thing we’d emphasise with all our clients, it’s this: treat family members as you would any other employee.

This means:

• Written contracts of employment
• Job descriptions outlining actual duties
• Regular payment through payroll
• Holiday and absence records
• Evidence of work completed

Without this documentation, you’re potentially opening yourself up to HMRC challenges. We’ve seen cases where perfectly legitimate family employment arrangements were questioned simply because paperwork was lacking.

Setting appropriate pay levels

Another red flag for HMRC is unrealistic pay. If you’re paying your 17-year-old son more than experienced professionals in your field, expect questions. A sensible approach is to check local job listings for similar positions and keep pay in line with market expectations.

Beyond Salaries: Pension Opportunities

One often-overlooked benefit of employing family members is the opportunity to contribute to their pensions. This can be especially valuable as:

• Company pension contributions aren’t subject to National Insurance
• They reduce your corporation tax bill
• They build retirement wealth within the family

Getting started with family employment

Ready to explore whether employing family members could work for your business? Book a free family employment review with our team. We’ll look at your specific situation and identify legitimate opportunities that could save you tax. If you’re already employing family members, let us check your arrangements to ensure they’re robust enough to withstand HMRC scrutiny. A small adjustment now could save significant headaches later.

Remember, employing family members isn’t about creating artificial arrangements – it’s about recognising and properly rewarding the real contribution your loved ones make to your business success. With proper planning and documentation, it’s a strategy that can benefit everyone.

Have questions about employing family in your business? Drop us a line for a friendly, no-obligation chat about your specific situation.

Frequently asked questions

Is it legal to employ my spouse in my limited company?

Yes, it’s completely legal to employ your spouse in your limited company. The key requirements are that they must actually perform work for the business, be paid a reasonable market rate, and all transactions must be properly documented and processed through payroll.

How much can I pay my child to work in my business?

You can pay your child whatever rate is appropriate for the work they’re doing, but it must reflect the actual value of their contribution. For children aged 16+, you must comply with National Minimum Wage regulations, while younger children have special restrictions depending on their age and local bylaws.

Do I need to pay National Insurance when employing my spouse?

If your spouse earns above the National Insurance Lower Earnings Limit (currently £6,240 per year), you’ll need to pay National Insurance contributions. However, if their earnings remain below the Primary Threshold (currently £12,570), they may accrue NI credits without actually paying contributions.

Can I employ my child under 16 in my business?

Yes, you can employ children under 16, but there are strict regulations about hours, types of work, and timing (especially during school hours). Local authority bylaws often require work permits for school-age children, and the work must be light and not harmful to their health, development or education.

Are there minimum wage requirements when employing family?

Family members who are aged 16 or over and who work as employees must be paid at least the National Minimum Wage relevant to their age group. There is no exemption from minimum wage laws for family members, so ensure you’re complying with current rates.

What happens if HMRC challenges my family employment arrangement?

If HMRC successfully challenges your arrangement, they may reclassify the payments as dividends or drawings, potentially resulting in additional income tax, National Insurance, and in some cases penalties. Having robust documentation of actual work performed is your best defence against such challenges.

Do family employees need contracts of employment?

Yes, family employees should have proper contracts of employment just like any other employee. This not only helps satisfy HMRC requirements but also clarifies expectations, protects both parties, and demonstrates the legitimate business nature of the arrangement.

Can I claim expenses for family members working in my business?

Family employees can claim legitimate business expenses following the same rules as any other employee. These must be wholly, exclusively and necessarily incurred in performing their duties, and should be properly documented with receipts.

What roles can family members legitimately perform in my business?

Family members can perform any role they are qualified and capable of handling, from administration and bookkeeping to marketing, sales, or technical work. The key is ensuring they have the appropriate skills for the role and that the work genuinely needs to be done within the business.