A Contract, Not a Convenience: Placing a Relative on the Payroll in 2026/27

Employing a husband, wife, civil partner or adult child is a long-established feature of small business life, and there is nothing improper about it. Where such arrangements come unstuck is rarely in the principle; it is in the paperwork. A salary that appears on the payroll without a corresponding body of work, a rate that cannot be justified and no evidence of payment is, to HMRC, a distribution of profit wearing an employment costume.

The distinction matters because it decides whether the cost is deductible. Two questions sit beneath every related-party salary: was there a genuine job, and was the pay for that job set on commercial terms? The National Insurance, the pension enrolment and the record-keeping all follow from how convincingly those two questions can be answered.

Begin with the duties, not the allowance

A common error is to work backwards from a family member's unused personal allowance — £12,570 at the time of writing — and then look for tasks to fill the gap. That approach inverts the logic and leaves an audit trail that reads as contrived.

The sounder sequence is to identify the duties first. What does the business actually need? Bookkeeping, credit control, customer scheduling, stock control, website maintenance, compliance filing, correspondence with suppliers? Then ask who performs them, how often, and what the role would cost if advertised. If the answer is that the business genuinely needs twenty hours a week of administrative support, a part-time salary is unremarkable. If the answer is that the duties amount to an occasional bank reconciliation, a full-time wage is not.

It helps to commit the role to paper before the first payment: a short job description, a contract of employment or a written statement of particulars, and a note of the hours expected. Documents created years later, in response to an enquiry, carry very little weight.

The reasonable-pay test in practice

The test is not whether the salary is convenient, but whether it is commensurate with the work. In practice, a defensible rate will usually be one of the following:

• The market rate for comparable duties in the locality, supported by a job advertisement, a salary survey or a recruitment quotation.
• The rate paid to an unconnected employee doing similar work in the same business.
• A rate derived from hours worked, multiplied by an hourly figure that the business can justify.

Where the figure is significantly above the market rate, the excess is exposed. HMRC may disallow the surplus as not incurred wholly and exclusively for the purposes of the trade, with the consequence that corporation tax relief is lost and the amount is recharacterised — typically as drawings or a distribution. The tax and National Insurance already paid are not always recoverable in the way one might hope, so the cost of an ambitious figure can exceed the saving it was designed to achieve.

Employment status and the National Minimum Wage

The National Minimum Wage applies to employees regardless of their relationship to the employer, subject to narrow exceptions. Genuine office holders, such as company directors, sit outside it; there are also limited exemptions for certain family and domestic arrangements. A spouse engaged under a contract of employment to perform administrative duties is, in principle, a worker for these purposes, and paying below the relevant rate is a compliance risk in its own right — separate from, and additional to, the deductibility question.

The interaction is worth pausing on. A rate that is too low to satisfy the minimum wage and too high to reflect the duties is a difficult position to defend from either direction. The rate should clear the statutory floor and align with the work.

National Insurance and the Employment Allowance

Employer National Insurance becomes payable once earnings exceed the secondary threshold — £5,000 at current rates — at 15 per cent. Employee contributions begin at the primary threshold, aligned with the personal allowance.

A salary set at £12,570 therefore produces employer contributions of roughly £1,135, offset in many cases by the Employment Allowance, which stands at £10,500 and is available where the employer's National Insurance bill is below £100,000. Two caveats apply. The allowance cannot be used against liabilities for domestic or personal staff, so it is only relevant where the employment genuinely belongs to the business. And a relative who already holds another job may have little or no personal allowance left, in which case the arithmetic changes considerably and the case for salary over dividends weakens.

Where a spouse has spare allowance and no other income, however, the combined effect of deductibility and lower marginal rates can be attractive — which is precisely why the arrangement attracts attention and why the supporting file matters.

Pensions and automatic enrolment

A salary above the earnings trigger — currently £10,000 — brings the relative into the automatic enrolment regime if they are aged between 22 and state pension age. Contributions are calculated on qualifying earnings, and the employer must enrol eligible staff, process any opt-out correctly and re-enrol at the statutory three-year point.

Postponement of up to three months is available, but the duties still apply. Paying a spouse just below the trigger to avoid enrolment is a legitimate structuring choice only where the salary genuinely reflects the work; used as a workaround, it has the same evidentiary weakness as any other contrived figure.

Where children are concerned

An adult child working in the business is treated in much the same way as any other employee: real duties, a commercial rate, a contract and payment through the payroll. Two additional points arise. First, the National Minimum Wage applies only to workers above compulsory school age, and the employment of school-age children is restricted by local authority byelaws on hours and permitted tasks. Second, a young employee's tax code and student loan position should be established before the first payroll run rather than corrected afterwards.

The file to keep

If HMRC asks, the following should be producible without reconstruction:

• A contract or written statement of particulars and a job description.
• Evidence of the work itself: rotas, timesheets, diary entries, email trails, invoices raised, software audit logs.
• Bank records showing the salary actually leaving the business account — not merely a credit to a director's loan account.
• Payslips and Full Payment Submissions, filed on or before each payday.
• A note of how the rate was set, and a periodic review showing it kept pace with the duties.

Records should be retained for at least three years after the end of the tax year for which the return was filed, and longer where other obligations apply.

A note on settlements

Separate from the salary question sits the settlements legislation, which can attribute income back to the person who provided the underlying asset. It is rarely engaged by a straightforward wage for work done, but it is engaged where shares or other income-producing assets are transferred between spouses without a commercial basis. The two issues are sometimes confused; they should be considered separately.

The practical conclusion

A family salary is neither a tax scheme nor a red flag in itself. It is an employment cost, and it should be documented like one. Directors who can show a job, a rate and a payment — in that order — have little to fear from a review. Those who can show only a payroll entry have rather more.

This article provides general guidance and does not constitute professional advice. Thresholds and rates should be confirmed against current HMRC published figures before any decision is taken.