Inside IR35 vs Outside IR35: Financial Impact

The financial difference between being inside and outside IR35 is not trivial. For many contractors, it is the difference between contracting being financially worthwhile and it barely beating permanent employment. Yet surprisingly few contractors have sat down and calculated exactly what the difference means in pounds and pence. In this guide, I will show you the precise financial impact of IR35 status at different income levels, using real 2025/26 tax year figures.

How Tax Works Outside IR35

When you are outside IR35, you operate through your personal service company (PSC) as a genuine business. The company receives your contract income, and you extract money from the company through a combination of salary and dividends. This structure is tax-efficient because:

Corporation tax is currently 25% on profits (with the small profits rate of 19% for profits under £50,000). This is typically lower than the combined income tax and National Insurance that an employee would pay on the same income.

Dividends are taxed at lower rates than employment income: 8.75% at the basic rate, 33.75% at the higher rate, and 39.35% at the additional rate (2025/26 rates). There are no National Insurance contributions on dividends.

The optimal strategy for most contractors outside IR35 is to take a small salary (typically around the NI primary threshold of approximately £12,570) and extract the remainder as dividends. This minimises the combined tax and NI liability.

How Tax Works Inside IR35

When you are inside IR35, the income you earn through your PSC is treated as if it were employment income. The fee-payer (usually the agency or client) deducts PAYE income tax and employee National Insurance before paying your company. Employer National Insurance is also due.

You can deduct a 5% allowance from the gross income to cover running costs of the PSC, but this is a modest concession. The practical effect is that you pay tax at employment rates, losing the dividend tax advantage entirely.

According to HMRC's off-payroll working guidance, deemed employment payments inside IR35 are subject to PAYE and NIC in the same way as employment income.

Worked Example: £400 Per Day (Approximately £88,000 per year)

Let me work through a realistic example for a contractor earning £400 per day, working 220 days per year, giving gross income of £88,000.

Outside IR35

• Gross company income: £88,000
• Allowable expenses (accountant, insurance, travel, etc.): £5,000
• Corporation tax profit: £83,000
• Corporation tax (19% small profits rate on £50,000, 25% on remainder): approximately £17,820
• Available for extraction: £65,180
• Salary taken: £12,570 (at the NI threshold)
• NI on salary: approximately £0 (at the threshold)
• Remaining dividends: £52,610
• Tax on dividends: Basic rate (£37,700 - £12,570 = £25,130 at 8.75%) = £2,199; Higher rate (£52,610 - £25,130 = £27,480 at 33.75%) = £9,275
• Total take-home: approximately £63,706

Inside IR35

• Gross company income: £88,000
• 5% allowance: £4,400
• Deemed employment income: £83,600
• Employer NI (approximately 13.8%): £9,802
• Income subject to PAYE: £73,798
• Income tax: (£12,570 at 0%) + (£37,700 at 20%) + (£23,528 at 40%) = £16,951
• Employee NI (8% on earnings above threshold up to UEL, 2% above): approximately £4,897
• Total take-home: approximately £52,950

The Difference

The contractor takes home approximately £10,756 more per year outside IR35. Over a five-year contract, that is over £50,000. This is why IR35 status matters so much.

Worked Example: £600 Per Day (Approximately £132,000 per year)

For a higher-earning contractor at £600 per day, 220 days, gross income of £132,000:

Outside IR35

After corporation tax, optimal salary/dividend split, and allowable expenses, the approximate take-home is £90,000-95,000.

Inside IR35

After PAYE, employee NI, and employer NI deductions, the approximate take-home is £72,000-76,000.

The Difference

The gap widens at higher incomes, with the contractor losing approximately £18,000-20,000 per year inside IR35.

What About the Employer's NI?

One of the most significant costs of being inside IR35 is employer's National Insurance. At 13.8% on earnings above the secondary threshold, this is a substantial amount that is deducted before income tax and employee NI are calculated.

The employer's NI effectively reduces the amount available for the contractor's pay. This is a hidden cost that many contractors do not fully appreciate until they see it on their payslip.

Some contractors negotiate a higher day rate to compensate for inside IR35 status, but this is not always possible, particularly in competitive markets. The uplift needed to maintain the same take-home as outside IR35 can be 15-25%, which many clients are unwilling to pay.

Is Inside IR35 Always Worse Than Permanent Employment?

Not necessarily. Inside IR35, you can still deduct the 5% allowance, you may have more flexibility than a permanent employee, and you retain the ability to work for multiple clients. However, the tax savings compared to permanent employment are minimal, and you lose employment rights such as holiday pay, sick pay, pension contributions, and redundancy protection.

For many contractors, if a role is genuinely inside IR35, the question becomes whether contracting is still preferable to permanent employment. The answer depends on factors beyond tax: flexibility, variety of work, and career control all play a role.

For a detailed analysis of how your specific situation might play out, see my guide on IR35 tax calculations.

Strategies for Managing IR35 Impact

If you find yourself inside IR35, there are limited but real strategies to mitigate the impact:

Claim the 5% allowance. This covers the costs of running your PSC, including accountancy fees, insurance, and administration. It is modest but should always be claimed.

Pension contributions. You can make employer pension contributions from your PSC, which are deductible as a business expense and reduce the income subject to tax. This is one of the most tax-efficient strategies for inside IR35 contractors.

Negotiate a higher rate. If the client determines you are inside IR35, negotiate a rate uplift to compensate for the additional tax cost. A 15-20% increase is a reasonable starting point.

Consider alternative working arrangements. If the IR35 determination is borderline, discuss changes to your working practices that might move you outside IR35. This might include introducing a genuine substitution clause, gaining more control over your methods, or working off-site.

Review each engagement independently. Being inside IR35 for one client does not mean you are inside for all clients. Each engagement is assessed separately, so your next contract may have different characteristics.

According to IPSE research, many contractors have adjusted their working arrangements or negotiated rate increases in response to IR35 determinations.

The Bigger Picture

IR35 status affects your finances, but it should not be the sole factor in your career decisions. Some contractors accept inside IR35 roles for excellent clients, interesting projects, or strategic career moves. Others refuse to work inside IR35 under any circumstances.

The key is to make informed decisions. Know the financial impact, understand your options, and choose deliberately rather than by default.

For help managing your contracting finances — whether you are inside or outside IR35 — Accounted handles bookkeeping, tax deductions, and self-assessment filing. Visit our pricing page to find a plan that suits your needs.

And for the complete picture on IR35, start with my IR35 explained guide and work through the linked articles for each specific aspect of the legislation.

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