Jennifer Adams considers how employing a spouse/civil partner can reduce a business's tax bill.
Running your own business can be exciting as well as challenging; as a business grows, there may be situations where an extra pair of hands is needed to help with the smooth running of that business.
Employing a spouse/civil partner (or family member) not only enables the business owner to concentrate on maximising income, but paying them a salary can be one of the more efficient ways of reducing tax.
Wholly and exclusively?
Tax relief for the payment will be allowed so long as that spouse/civil partner does some work 'wholly and exclusively’ for the purposes of the business. The payment must be commercially viable, and the amount realistic and not excessive for the work undertaken.
In a basic situation involving a sole trader business, excessive remuneration paid to a spouse/civil partner is simply disallowed in computing taxable profits. In a company, not only will it be disallowed but it is likely also to be treated as an effective distribution to the director/shareholder, resulting in income tax liabilities.
Alternatively, HMRC could treat the payment as remuneration of the director, deeming it to be payment diverted to that director’s spouse/civil partner under the 'settlement rules'. The question here is whether by allowing the family member income from the business is she/he actually earning a PAYE salary or has the owner-director created a ‘settlement’ for income tax purposes?
Aside from the payment amount needing to be similar for comparable work outside the business, consideration is needed to ensure that the tax relief is not counteracted by a higher tax bill for the spouse/civil partner. Although the national minimum wage is not relevant in this situation, whether the spouse/civil partner is lacking in National Insurance credits towards their state pension may have a bearing on the decision as to whether to employ and if so, the amount to pay. In addition, an employee’s salary counts as ‘relevant earnings’ to enable private pension contributions.
What’s the optimum amount?
The optimum amount payable will depend upon various factors, including whether:
- the family member has another job or income, and if so, how much personal allowance remains to be allocated against the salary.
- the transferable marriage allowance is available.
- the employee is over state pension age as no NICs are payable, or under 21 years as no employer's NICs are payable.
- Class 4 NICs are payable for a sole trader, or employer's NICs for a company.
- Employment allowance can be claimed (enabling eligible employers to reduce their annual NICs liability by up to £4,000).
As a guide, if full allowances are available to the spouse/civil partner, then £8,788 is a tax-efficient salary to pay as there is no liability to NICs or tax. In addition, this amount is above the NICs lower earnings limit required to qualify for state benefits (i.e. £6,240 for 2020/21). Tax relief for the business will be at the marginal rate for income tax, or 19% for corporation tax purposes.
Should employment allowance not be available, the optimal salary amount will be equal to the personal allowance (i.e. £12,500 for 2020/21), as no employers’ NICs will be due; this is, of course, assuming that the personal allowance is not utilised elsewhere. Although employees' NICs will be payable at 12% on salary in excess of the primary threshold (i.e. £9,500), this amount will be more than offset by a corresponding reduction in the tax charged on the business, be that income or corporation tax.
Practical tip
The salary should be paid into the spouse/civil partner's personal bank account and recorded in the accounts as payment to another employee. Payment should not be made into a joint account, as it could be argued that the owner has not really paid the funds and still has access to them.
