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Inside vs outside IR35 — the 2025/26 contractor's guide

By the PaySlipCheck Editorial team · 15 May 2026 · 10 min read

Inside IR35 means the contract is treated like employment: you're paid through PAYE (usually via an umbrella company), with Income Tax and NI deducted at source. Outside IR35 means the contract is genuinely freelance: you can invoice through your own limited company and pay yourself a tax-efficient mix of salary and dividends. The difference is worth around 10–15 percentage points of your day rate in your pocket — but only if your contract genuinely is outside IR35.

The 30-second version

For an exact comparison on your day rate, our day rate / IR35 calculator models both paths side by side.

What IR35 actually is (and isn't)

IR35 is the nickname for the off-payroll working rules — anti-avoidance legislation introduced in 2000 to stop people leaving a permanent job on Friday and returning as a "contractor" doing the same job on Monday, but at half the tax rate. The rule says: if your working relationship looks like employment in all but name, you should be taxed like an employee, even if you're invoicing through a limited company.

What "looks like employment" means in practice is messy and case-law-driven. Three factors carry the most weight in HMRC's assessment:

1. Substitution — can you send someone else to do the work in your place? Real freelancers can; employees can't. A genuine right of substitution, exercised at least once, is the single strongest "outside" indicator.
2. Mutuality of obligation (MOO) — does the client have to offer you work, and do you have to accept it? Employees yes, contractors no.
3. Control — does the client direct how, when and where you work? The more control they exercise (set hours, line manager, requirement to attend internal meetings), the more it looks like employment.

Several smaller factors also count: do you provide your own equipment, do you take financial risk, are you "part and parcel" of the organisation (named in the org chart, on the company directory, attending all-hands), how many clients you have, and whether you'd be paid if the project failed.

Who decides if you're inside or outside

This is the part that changed in 2021 and trips up most contractors.

• Public sector (since April 2017) and private sector medium/large companies (since April 2021): the end client determines your IR35 status, not you. They issue a Status Determination Statement (SDS) at the start of the engagement.
• Small private companies (turnover under £10.2m, ≤50 employees, balance sheet under £5.1m — meet any two): the contractor's own Ltd company still decides. This is the "old" pre-2021 regime.
• Overseas clients with no UK presence: contractor's Ltd company decides.

If you disagree with the SDS, you have 45 days to challenge it through the "client-led dispute resolution process". Be aware that many clients took a blanket "inside" approach in 2021 to avoid the risk of getting it wrong — that's been slowly relaxing as the market matures but is still common in financial services and the public sector.

If your contract sits in the grey area, a professional contract review is worth £80–£200 for the peace of mind. FreelanceToolkitUK keeps an updated guide on getting your contract reviewed for IR35 — who the reputable providers are and what a good review actually looks at.

How tax works inside IR35

You're paid via an umbrella company, which acts as your employer. Your day rate has the following deducted from it before you see the money:

1. Employer's National Insurance at 15% on earnings above £5,000 (2025/26).
2. Apprenticeship Levy at 0.5% (large umbrellas only — most pass it on).
3. Umbrella margin, typically £15–£25 per week.
4. Holiday pay accrual — sometimes rolled into your headline rate, sometimes held back and paid when you take leave.

What's left becomes your taxable salary. From that, you then pay:

• Income Tax at 20%/40%/45% via PAYE.
• Employee's NI at 8% / 2%.
• Pension contributions (auto-enrolment minimum 5% unless you opt out).
• Student loan if applicable.

Practical effect: on a £500/day contract working 46 weeks of the year (£115,000 revenue), you'd typically take home around £73,000–£77,000 after everything. That's roughly 65% of revenue.

How tax works outside IR35

You invoice through your own Ltd company. The company books the revenue and you pay yourself in two ways:

Salary (small, up to personal allowance)

Most contractors pay themselves a director's salary of around £12,570 (the personal allowance) — high enough to count as a "year" for State Pension purposes, low enough to attract zero Income Tax and minimal NI. The salary is also a tax-deductible expense for the company, reducing Corporation Tax.

Dividends (the bulk)

The remaining company profit, after Corporation Tax, comes out as dividends. For 2025/26:

• £500 dividend allowance — tax-free.
• 8.75% on dividends in the basic-rate band.
• 33.75% in the higher-rate band.
• 39.35% in the additional-rate band.

Dividends aren't subject to NI. That's the main reason outside-IR35 take-home is higher than inside.

Corporation Tax

Most one-person contractor companies sit in the £50k–£250k band, paying around 26.5% on the profit slice above £50k.

Allowable expenses

The big advantage of Ltd company life is that legitimate business costs come off your taxable profit:

• Accountant fees (typically £80–£150/month for a contractor — try FreeAgent or Crunch)
• Software subscriptions (project management, Adobe, etc.)
• Training and professional development
• Business travel (not commuting to a single client site for >24 months)
• Mobile and broadband (business proportion)
• A small home-office allowance (£6/week with no receipts, or actual cost with apportionment)
• Professional indemnity insurance

Practical effect: on the same £500/day, 46-week contract (£115,000 revenue), an outside-IR35 contractor with £3,000 of allowable expenses typically takes home around £84,000–£88,000. That's roughly 75% of revenue — £10,000 more per year than the inside-IR35 version.

The hidden costs of outside IR35

Before you assume outside is always better, count the costs:

Administrative time

Running a Ltd company is not heavy — but it isn't nothing. Reckon on a couple of hours a month for bookkeeping, an hour at year-end for the company accounts (your accountant does the heavy lifting), and an evening in January for Self Assessment. Cloud accounting software like FreeAgent, Xero or QuickBooks reduces this significantly.

Accountant fees

Annual costs typically £900–£1,800 for a contractor accountant. Worth every penny if your day rate is £400+ — the corp-tax planning alone usually pays the fee back.

Business banking

You need a business bank account. Tide, Starling Business and Revolut Business are all free or very low cost. If you invoice overseas clients, Wise Business saves significant FX margins.

Investigation risk

HMRC can challenge an outside-IR35 determination retrospectively. Since 2021 the liability sits with the end client in most cases, but for small-company exemptions and pre-2021 contracts the contractor can still be in the firing line. Standard insurance from Markel, Qdos or Kingsbridge runs £150–£300 a year and is worth having.

No employee benefits

No sick pay, no maternity/paternity from a client, no employer pension match, no holiday entitlement, no statutory notice. Day rates are higher partly because they have to be — you carry the risk.

Worked example: £600/day for 9 months

9 months × ~22 working days × £600 = £118,800 revenue. Assume the contractor takes 4 weeks holiday during the contract = ~£106,000 effective annual revenue if extrapolated.

The £11,400 difference is the IR35 premium. For a long-running contract that's a real number. For a 3-week stint it's not worth the company setup cost.

Decision framework

• Contract length under 3 months and inside IR35 on offer: take the umbrella, don't set up a company.
• Contract genuinely outside IR35 and day rate above £350: form a Ltd company. The maths and the optionality (multiple clients, expenses, pension contributions through the company) are clearly worth it.
• Day rate £200–£350 and outside IR35 on offer: marginal call. The £900+ annual accounting cost eats most of the saving on lower rates.
• "Disguised" outside-IR35 offer (low day rate plus expenses paid): probably actually inside. Don't be the one HMRC challenges in 4 years.
• Mixed portfolio of contracts, some inside some outside: keep the Ltd company, run inside-IR35 contracts through an umbrella alongside. Plenty of contractors do this.

What's changed recently

• April 2024: the "offset" rule means if HMRC decides a contract is inside IR35 retrospectively, they now offset the tax the contractor already paid through their Ltd company. Before this, end clients faced "double taxation" risk, which made many of them blanket-inside. The offset has slowly reopened outside-IR35 contracts in 2024–2026.
• April 2024: Class 2 NI for the self-employed was abolished. Doesn't directly affect Ltd company contractors but matters if you also have sole-trader income.
• April 2024: Class 4 NI for the self-employed was cut from 9% to 6%, narrowing the gap between sole-trader and Ltd-company take-home for low-profit businesses.
• Dividend allowance was cut from £1,000 to £500 in April 2024 and remains £500 for 2025/26.

Related: Day rate / IR35 calculator · Umbrella vs limited company in detail · Dividend tax rates 2025/26 · Sole trader vs limited company