Employing Family Members: Tax Savings, HMRC Risks and What to Get Right

‍‌‌‌​‌‌‌​‌​‌‌​‌​​‌‌‌​‌‌‌​​‌‌‌​‍Putting family on the books can be smart, but HMRC treat it like any other payroll -- if the work or pay looks fake, they'll go after it.

3.26.1 When it's legit -- and when HMRC will kick off

You can employ your partner or kids, but you must run it like a normal job.

HMRC expect

• Genuine work -- they actually do something the business needs (admin, quotes, social media, labouring, bookkeeping, van runs).
• Commercial pay -- roughly what you'd pay a non-family worker for the same hours and skills, not £12k for "answering the odd phone call".
• Proper records -- contract, payslips, timesheets, bank transfers, evidence of work (emails, schedules, photos).
• PAYE run correctly -- you register as an employer, deduct tax/NI, file RTI, give P60s/P45s.

If HMRC look and see no evidence of work, silly-high pay, or the job only started when profits jumped, they can:

• Disallow the wages as a business expense.
• Re-tax you personally, plus interest and penalties.

What "reasonable" actually looks like

A concrete example: spouse doing 10 hours/week of bookkeeping and quote admin at £12/hour = £6,240/year. That's within the personal allowance, so no tax due. Real work, real hours, real pay, paid into their own bank account -- HMRC won't blink at that.

Compare: spouse on £12,500/year for "general help" with no timesheets, no evidence, and no clear job description -- that's the kind of arrangement that triggers questions.

Arctic Systems and income-splitting

The Jones v Garnett (Arctic Systems) case was about splitting company profits with a spouse via shares/dividends. The upshot was that income-splitting through genuine share ownership can work, but HMRC still attack arrangements that are contrived or don't match the reality.

The law HMRC use is the settlements provisions in the Income Tax (Trading and Other Income) Act 2005, ss.619-648. If they think you've diverted income to a spouse purely to save tax without genuine commercial purpose, they can tax it as yours.

3.26.2 Minimum wage and the family member "exemption"

Big misconception: "It's family, so I don't have to pay minimum wage."

Reality

For most family working in a trades business, you do have to pay at least National Minimum Wage / National Living Wage if they're a "worker".

There is a very narrow exemption where NMW doesn't apply to a family member who:

• Lives in the employer's family home, and
• Helps in the running of a family business from that home, and
• Shares in family tasks and activities, and isn't paying for accommodation/meals.

That's really aimed at people like live-in au pairs or someone helping in a business run from the family home.

Crucial bit

A limited company cannot have a "family" or family home, so the exemption does not apply to family on the payroll of your Ltd company.

So:

• Sole trader with your partner helping in the home office: very tight conditions before you can claim they're outside NMW.
• Limited company: treat spouse/partner/kids as normal workers -- NMW rules apply in full.

3.26.3 Kids in the family business (under 16)

You can get them involved, but the law is strict.

Basics

• Under 13 -- generally cannot be employed.
• 13+ -- can work, but:
  • Local council by-laws set what jobs they can do, hours, and days.
  • No work during school hours, not before 7am or after 7pm, limited hours on school days and holidays.
  • You usually need a child employment permit from the council, even for your own kids, and you must do a basic risk assessment.

Any "helping out" that looks like regular work without a permit is technically illegal and your EL insurance may not respond properly if they get hurt.

From HMRC's side, same principles: work must be real, age-appropriate, paid at a sensible rate, and put through PAYE if the amounts warrant it.

3.26.4 NI, tax and structure

Income tax

Income Tax (Earnings and Pensions) Act 2003 -- family wages are just normal employment income; if the job is real and pay is reasonable, the wage is usually deductible for the business.

National Insurance

If earnings go over the thresholds, both employer's and employee's NI kick in as usual; below that, you still report via PAYE if you're on the payroll.

Employment Allowance

If you employ a family member and you're not already claiming it, the Employment Allowance (currently £5,000/year off your employer's NI bill) can make employing a spouse or partner almost free in NI terms for a small firm. This is one of the main financial reasons trades put a spouse on the books.

You can claim it if:

• Your employer's NI bill in the previous tax year was under £100,000.
• You're not a single-director company with no other employees (the sole director exclusion).

So a sole trader or small ltd company with a spouse on the books usually qualifies.

Limited company: salary vs dividends

For limited companies, paying a spouse a salary is one route; another is having them as a shareholder and paying dividends. But that's where the Arctic Systems / settlements rules and anti-income-shifting rules bite if it's clearly artificial.

Bottom line: you can absolutely use your spouse's allowance and lower tax bands, but only by paying them properly for proper work or giving them a genuine stake in a company, not by inventing a phantom job.

3.26.5 Auto-enrolment -- no family exemption

If your family member earns above the auto-enrolment threshold (currently £10,000/year), you must enrol them in a workplace pension -- no family exemption.

• The Pensions Regulator doesn't care that it's your spouse -- they're an employee, they qualify, they get enrolled.
• Many small firms don't realise this until the Pensions Regulator writes to them.
• If you're paying a family member just under the threshold partly to avoid this, HMRC and TPR may take an interest if it looks like the pay has been artificially set.

3.26.6 Maternity, paternity and the HMRC trigger

If your employed spouse gets pregnant, they're entitled to Statutory Maternity Pay (SMP) if they meet the qualifying conditions -- same as any other employee.

• HMRC will pay most of it back to you via the SMP recovery scheme -- small employers (under £45,000 NI liability) can recover 103% of SMP paid.
• But -- if HMRC think the employment is artificial (no real work, timed suspiciously around pregnancy, pay suddenly increased before the qualifying period), they can refuse SMP. This is a known trigger for HMRC investigation into family employment.
• The safest position: have the employment set up well before any pregnancy, with genuine work and records from the start.

3.26.7 Employer's Liability insurance

If you employ family members, you need EL insurance covering them -- there's no general family exemption.

• The only exception is very narrow: a sole trader whose only employee is their spouse (and no one else) is technically exempt from the compulsory EL requirement. But even then, having EL is strongly recommended -- if your spouse is injured doing work for you, you want cover.
• Limited companies must have EL insurance covering all employees including family members, no exceptions.
• Make sure family members are declared to your insurer -- if they're not on the policy and something happens, the claim may be refused.

What to do next

• Talk to a local accountant who actually works with small trades -- they'll tell you what's normal for a spouse/teen role and set pay at a defensible level.
• Register as an employer with HMRC if you're not already, and set up PAYE properly.
• For under-16s, check your council by-laws and get a work permit if needed; don't just chuck them in the van and hope.
• Write a simple job description and contract for each family member -- treat them like you would a non-family hire in terms of paperwork and hours.
• Check Employment Allowance eligibility -- it can make the NI cost of employing a spouse almost zero.
• Check auto-enrolment obligations if paying above £10,000/year.
• Tell your EL insurer about any family members working for you.

Sources

• Income Tax (Earnings and Pensions) Act 2003 -- legislation.gov.uk/ukpga/2003/1/contents -- employment income rules applying to family wages.
• Income Tax (Trading and Other Income) Act 2005, ss.619-648 -- legislation.gov.uk/ukpga/2005/5/contents -- settlements provisions used by HMRC to challenge income-splitting.
• National Minimum Wage Act 1998 -- legislation.gov.uk/ukpga/1998/39/contents -- NMW obligations including the narrow family member exemption.
• National Minimum Wage Regulations 2015, reg.57 -- legislation.gov.uk/uksi/2015/621/contents -- the specific family worker exemption conditions.
• Employers' Liability (Compulsory Insurance) Act 1969 -- legislation.gov.uk/ukpga/1969/57/contents -- EL insurance requirements and the spouse exemption for sole traders.
• Pensions Act 2008 -- legislation.gov.uk/ukpga/2008/30/contents -- auto-enrolment duties.
• Children and Young Persons Act 1933 -- legislation.gov.uk/ukpga/Geo5/23-24/12/contents -- restrictions on employing children.
• Jones v Garnett (Arctic Systems) [2007] UKHL 35 -- House of Lords ruling on income-splitting through spouse shareholders.
• HMRC guidance on employing family members -- gov.uk -- running payroll, allowable deductions, and record-keeping.

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