Whether a contract is "inside" or "outside" IR35 determines how you are taxed, and the difference in take-home pay is material. For a contractor on a typical day rate, IR35 status alone can shift the effective tax rate by more than ten percentage points. The size of the gap on your own numbers is what the IR35 take-home calculator is for; this article explains the mechanics that drive it.
The Core Difference
Outside IR35: You operate through your Personal Service Company (PSC) as a genuine business. You pay yourself a tax-efficient combination of salary and dividends, and the company pays Corporation Tax on its profits.
Inside IR35: HMRC considers you a "deemed employee" of your client. Your income must be processed through PAYE, with Income Tax and National Insurance deducted as if you were an employee, but without employment benefits such as holiday pay, sick pay, pension contributions, or employment rights.
Why the Gap Exists
Three mechanics drive the outside-vs-inside spread, and all three move in the same direction.
- -Employer's NIC. Inside IR35, the deemed payment carries employer's NIC on the fee-payer side. Outside IR35, dividends carry no employer's NIC at all, and the low director salary sits below most of the NIC threshold.
- -Corporation Tax versus combined NIC + Income Tax. Outside IR35, profits are taxed at Corporation Tax rates before extraction. Inside IR35, the equivalent slice is hit by combined employer and employee NIC plus Income Tax, which totals more.
- -Dividend rates versus PAYE. Dividends within the basic-rate band are taxed at 10.75% (2026/27). Inside IR35, the same slice is earned income taxed at 20% with employee NIC on top. The gap widens as income moves into the higher-rate band.
Inside IR35 also allows a 5% deemed expense allowance on the gross contract value, covering costs the fee-payer does not reimburse. Outside IR35, real business expenses, insurance, accountancy, travel to temporary workplaces, come off the top before Corporation Tax. The 5% cap is almost always the worse deal.
To see the spread on your own day rate and billable days, use the IR35 take-home calculator.
What Determines Your IR35 Status?
Since April 2021, the end client (not the contractor) is responsible for determining IR35 status for medium and large private sector organisations. They issue a Status Determination Statement (SDS) before the engagement begins. Our IR35 guide covers the three key tests in detail: substitution, control, and mutuality of obligation.
Strategies for Outside IR35 Contractors
If your contract is outside IR35, you have full control over your extraction strategy. The optimal approach for most contractors in 2026:
- -Salary of £12,570, uses your Personal Allowance, qualifies for State Pension, minimal NIC.
- -Dividends up to £50,270 total income, stays within the basic rate band (10.75% from April 2026).
- -Employer pension contributions, for profits above the basic rate band, pension contributions are more tax-efficient than dividends. See our Salary vs Dividends for the full calculation.
- -Retain profits in the company, if you do not need the cash immediately, leaving it in the company avoids personal tax entirely until you extract it.
Options for Inside IR35 Contractors
If your contract is inside IR35, your options narrow considerably. The deemed payment rules mean most income is taxed as employment income. However, there are still steps you can take:
- -Claim the 5% deemed expenses allowance, this covers travel, subsistence, and other costs not reimbursed by the client.
- -Employer pension contributions, your PSC can still make employer pension contributions, which are deductible before the deemed payment calculation.
- -Challenge the determination, if you believe the client's SDS is incorrect, you have the right to dispute it. We review contract terms and working practices to build your case.
Frequently Asked Questions
Can I still use a limited company for inside IR35 contracts?
Yes, but the tax advantage largely disappears. You must operate a deemed payment through your PSC, paying PAYE and NIC as if you were an employee. Some contractors use umbrella companies for inside IR35 work to simplify the administration, keeping their PSC for outside IR35 engagements.
Who is responsible for determining IR35 status?
For medium and large private sector clients, the end client determines your status and issues a Status Determination Statement (SDS). For small company clients (under 2 of: £10.2m turnover, £5.1m balance sheet, 50 employees), the contractor retains responsibility for their own IR35 assessment.
Should I take a permanent role instead of contracting inside IR35?
It is a commercial decision, not just a tax one. Inside IR35 contracting pays the same tax as employment but without employment benefits. However, day rates for inside IR35 roles are typically 20-30% higher than equivalent permanent salaries. Management accounts help you compare the two on a total-compensation basis.