IR35 Explained: What Every Contractor Needs to Know in 2026

The Accounted Business Team·10 March 2026·7 min read

IR35 is probably the single biggest tax issue facing contractors who work through their own limited company. Get it wrong and you could face a hefty tax bill, penalties, and interest stretching back years. Get it right and you can legitimately keep more of what you earn.

This guide explains what IR35 actually is, how to tell whether you are inside or outside, who decides your status, and what practical steps you can take to stay on the right side of the rules.

What Is IR35?

IR35 is the common name for the off-payroll working rules. The actual legislation sits in Chapter 8 of the Income Tax (Earnings and Pensions) Act 2003, but everyone calls it IR35.

The rules exist to catch what HMRC calls "disguised employment." The idea is simple: if you work through a limited company but your working relationship looks essentially like employment, you should pay roughly the same tax and National Insurance as an employee.

Without IR35, a worker could leave their employer on Friday, set up a limited company over the weekend, and return to the same desk on Monday doing the same job — but paying significantly less tax by taking income as dividends instead of salary.

Inside IR35 vs Outside IR35

When people talk about being "inside" or "outside" IR35, they mean:

Inside IR35

Your contract falls within the off-payroll rules. The working relationship is essentially employment in all but name. Tax and National Insurance must be deducted at source as if you were an employee. You lose most of the tax benefits of working through a limited company.

Outside IR35

Your contract genuinely reflects a business-to-business relationship. You are running your own business, taking commercial risk, and operating independently. You can pay yourself through a mix of salary and dividends in the normal way.

The difference in take-home pay is significant. A contractor earning £100,000 a year outside IR35 could take home roughly £20,000 to £25,000 more than someone inside IR35 on the same day rate, depending on their exact tax planning.

Who Decides Your IR35 Status?

This is where the rules have changed significantly. Before April 2021, if you worked through your own limited company, you decided your own IR35 status. Since April 2021, the responsibility has shifted — but only for medium and large end clients.

Medium and Large Private Sector Clients

If your end client is a medium or large company, they must determine your IR35 status before the engagement begins. They issue a Status Determination Statement (SDS) explaining their decision and the reasons behind it. If they determine you are inside IR35, the fee-payer (usually the agency or the end client) must deduct tax and NICs before paying your company.

A medium or large company meets two or more of these criteria:

Annual turnover of more than £10.2 million
Balance sheet total of more than £5.1 million
More than 50 employees

Small Private Sector Clients

If your end client is a small company (does not meet two of the criteria above), the old rules still apply. You, the contractor, are responsible for determining your own IR35 status. This is a genuine advantage of working for smaller clients, because you retain control of the assessment.

Public Sector Clients

Public sector bodies have been responsible for determining IR35 status since April 2017. The rules here work the same as for medium and large private sector clients.

The Three Key Factors

Employment status is not a simple tick-box exercise. Courts and tribunals look at the overall picture, but three factors carry the most weight.

Control

Does the end client control how, when, and where you do the work? An employee is told what to do and how to do it. A genuine contractor is engaged to deliver a result and decides how to achieve it.

Ask yourself: Can the client tell you to work specific hours? Must you work at their premises? Do they direct your methods and processes? If yes to most of these, that points inside IR35.

Substitution

Could you send someone else to do the work in your place? A genuine right of substitution is one of the strongest indicators of self-employment. But it has to be a real, practical right — not just a theoretical clause in a contract that would never be exercised.

If the client would refuse a substitute, or if the nature of the work means only you can do it, this points inside IR35.

Mutuality of Obligation

Is the client obliged to offer you work, and are you obliged to accept it? In employment, the employer must provide work and the employee must do it. In a genuine contract for services, either party can walk away once the current deliverable is complete.

If you have a rolling contract with no defined project or end date, and you are expected to turn up every day, that looks like mutuality of obligation — pointing inside IR35.

Other Factors That Matter

Beyond the big three, tribunals also consider:

Financial risk. Do you risk your own money? Could you make a loss? Employees cannot make a loss from their employment.
Equipment. Do you provide your own tools, software, or equipment? Using the client's kit points towards employment.
Part and parcel. Are you integrated into the client's organisation? Do you attend staff meetings, have a company email, or appear on the org chart?
Exclusivity. Can you work for other clients at the same time? Being restricted to one client looks like employment.
Intention. What did both parties intend the relationship to be? This carries less weight than the practical reality, but it is not irrelevant.

The CEST Tool

HMRC provides a free online tool called Check Employment Status for Tax (CEST). You answer a series of questions about the engagement and it gives you a determination of inside, outside, or undetermined.

CEST is worth using, but be aware of its limitations:

It does not consider mutuality of obligation in any meaningful way
Many engagements come back as "undetermined," which is not helpful
HMRC says it will stand by the result if the information entered is accurate, but contractors and their advisers have questioned this in practice

Use CEST as a starting point, not the final word. If you are in any doubt, get specialist IR35 advice from a tax professional or a status consultancy.

What Happens If You Get It Wrong?

If HMRC investigates and decides a contract should have been inside IR35, the consequences depend on who was responsible for the determination.

If the Client Was Responsible (Medium/Large)

The fee-payer (agency or end client) is liable for the unpaid tax and NICs. Your limited company is generally not on the hook, though there can be exceptions if you provided misleading information.

If You Were Responsible (Small Client)

Your limited company must pay the tax and NICs that should have been deducted, plus interest. If HMRC considers the failure to be careless or deliberate, penalties of up to 100% of the tax due can apply. Investigations can go back up to six years, or twenty years in cases of deliberate understatement.

Practical Steps to Protect Yourself

Get your contracts right. Make sure they reflect the actual working relationship. A contract that says "outside IR35" means nothing if the reality looks like employment.

Keep evidence. Document instances where you exercised substitution rights, turned down work, used your own equipment, or worked for multiple clients. If HMRC investigates years later, you will need this evidence.

Review each engagement separately. IR35 applies contract by contract. You might be outside on one engagement and inside on another.

Use insurance. IR35 tax investigation insurance can cover your legal costs if HMRC opens an enquiry. It is relatively cheap and well worth having.

Track your finances properly. Keeping clean, detailed records of your business income and expenses is essential. If you use Accounted, Penny automatically categorises your transactions and keeps an audit trail that shows your business is operating commercially, not as a disguised employment.

The Bottom Line

IR35 is not going away. If you are a contractor working through a limited company, understanding these rules is not optional — it is essential to running your business. Take the time to assess each contract honestly, keep good records, and get professional advice when the situation is unclear.

Accounted helps contractors stay organised with automatic bank feeds, receipt scanning, and clear profit tracking — everything you need to demonstrate you are running a real business. Try Accounted free and let Penny handle the bookkeeping while you focus on the work.

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