A few rules, however, do apply that you need to keep in mind:
• Your relative has to be hired to do real work at a proper commercial wages rate. HMRC are likely to query payments of £50 per hour to a 5-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 for you. 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 £139 (for 2011–12) in any week are liable for NICs. In addition, as the employer, you also have to pay NICs on their behalf.
• You must actually pay the money. HMRC may ask to see evidence that the money has gone from the business to the family member concerned. It is important to keep proper records of all payments made.
Bob runs a gardening services business from a workshop at the bottom of his garden. His 16-year-old son 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.
Bob can offset the £1,750 he pays his son against his profits for income tax purposes. Provided his son 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 (£7,475 in 2011–12).
If Bob had done the work himself and not employed his son, 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. National Insurance contributions may reduce the household income even further.
Employing a spouse or partner can be particularly tax-efficient if you are trading through a limited company. If your spouse or civil partner is a shareholder in the company, and is also employed in it, you can pay yourselves a mixture of salary/bonuses, benefits, and dividends, thereby reducing your overall tax bills quite considerably.
If Julian 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 higher rate tax bill will apply to the top slice of his income.
Contrast this with George and Sally who own 1% and 99% 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. Sally receives £19,800 (in relation to her 99% shareholding), whist George receives only £200. Sally’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% either. An alternative would be to pay Sally £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 down the dividend route, it still works out a good few thousand pounds less than paying the £50,000 salary straight to George.
Practical Tip :
If you employ your spouse or civil partner, you can currently pay him or her between £102 and £136 per week. Although there will be no liability to NICs, the employee’s entitlement to a future state pension and other state benefits will be protected.
This article was first printed in Tax Insider in February 2012.