A salary to your spouse

This is probably the most popular and well known “tax dodge” known to dentists. “Pub talk” will have it that all one does to get a tax deduction is to enter a figure in accounts just below the tax exemption limit of £4,895 and you have a potential tax saving of almost £2,000 per year. A fair number of dentists give no or little thought to actually paying their wives and recording the payment in their accounting records. Surely, they say, all one has to do is make a claim and the tax deduction is theirs? Well, not quite!

A wife’s salary is only liable as a tax deduction if it is incurred “wholly and exclusively” for the purposes of the practice. It is always sensible to keep good records of the work your wife does for the practice, in case the IR challenge the deduction. This does not have to be anything too sophisticated – a general job description will suffice.

Payment

In the landmark case of Moschi v Kelly (a case often used by the IR) it was held that as the sums described in the accounts as wife’s wages were merely book entries and had not actually been paid to her, they were not allowed as a tax deduction.

Certain steps are vital:

1. There must be payment – ideally into a separate bank account in the wife’s name. This can either be by wage of cheque or standing order. To identify a separate audit trail the bank account should not be a joint account but be in the name of the wife only.

2. The wife must in fact do some work for the practice for which her pay is reasonable. As specified above – this does not have to be a great deal.

3. One should perhaps consider a simple employment contract or a written statement of employment particulars, which is in fact a legal requirement. Further details can be obtained at http://www.dti.gov.uk/er/individual/statement-pl700.htm

How Much Should I Pay My Wife?

The smaller the amount you pay your wife, the easier it is to justify the charge. Assuming a salary of £4,895 and a reasonable hourly rate, a minimum working week of about 7 hours a week might be required. Surely not too difficult to justify? This can be in respect of such duties as going to the bank, answering the telephone and perhaps some basic bookkeeping or administrative work. Remember, the IR is not able to second guess the commercial rate for the job and substitute their own estimate. A tax inspector can only disallow the expense on the grounds that either it was not actually paid or it was not incurred exclusively for the practice. One also has to allow for the unsociable hours that a wife might have to work.

This aspect of a wife’s wages should seldom be a problem in practice. One simply needs to ask the question “Is the amount reasonable to pay for the services rendered?” Many associates will also want to consider employing their wife but perhaps their task in justifying the salary as a tax deduction is rather more problematic than for a principal. This is because the administrative burden is considerably less for an associate and hence would generally be harder to justify.

You can of course pay your wife a greater salary but don’t forget National Insurance or the fact that once you cross the tax and NI threshold of £4,895 you have to start operating a PAYE Scheme. Furthermore, above this level both employers NI of 12.8% and employee’s NI of 11% begin to bite. This combination usually makes the payment of salaries at higher levels, marginal at best. See Examples 1 and 2 for an illustration of this.

What the examples illustrate is that the savings arising from paying one’s wife above the tax exemption threshold of £4,895 are more than swallowed up by higher national insurance contributions – both employee’s and employers’.

Accordingly, there is little merit in paying a wife an amount above the tax threshold unless one were to consider paying a pension contribution on behalf of your wife – but that is another subject altogether!

Example 1: This assumes the husband is a higher rate tax payer and spouse is a non-taxpayer

Salary paid to wife	£4,895
Tax relief for employer @ 40%	(£1,958)
Saving from employing wife	£2,937

Example 2: National Insurance contributions by employer and employee make this option less attractive.

What it costs the employer after all deductions
Salary paid to wife	£18,000
Employer's NI @ 12.8%	£1,677
Total cost to employer	£19,677
Tax relief thereon @ 40%	(£7,870)
Net cost to employer (A)	£11,807
What the employee ends up with after all deductions
Gross pay from employer	£18,000
Tax paid	(£2,638)
National Insurance - employee	(£1,441)
Net pay received by wife (B)	£13,921
Saving from employing his wife (B)-(A)	£2,114

Willie MacKenzie is a chartered accountant and tax adviser specialising in the tax affairs of dentists. He can be contacted on 01483 419922, by email at wtm@accmac.plus.com or visit www.wesaveutax.co.uk