Contractor or employee in 2026: how the UK tax differs
Same headline rate, different take-home. A side-by-side of how the maths runs through PAYE vs a limited company in 2026/27.
The tax difference between UK employees and limited-company contractors is real, but it has narrowed since 2023. Below is how the same engagement runs through both paths in 2026/27, with the rules that actually apply today.
The setup
The same person, same client, same work:
- Employee: £90,000 PAYE salary, 5% employer pension match, standard 1257L tax code, no benefits in kind.
- Contractor (outside IR35): £600/day for 220 billable days — gross billings of £132,000. Limited company, sole director, ~£6,000 of legitimate company expenses, no other income.
Numbers below use 2026/27 rates for England, Wales and Northern Ireland. Reminder: the contractor scenario uses a higher gross engagement value (£132,000 of billings) than the £90,000 PAYE salary — closer to a £100k–115k total employer cost on the employee side, before the comparison runs.
Path A: the employee
| Item | Amount |
|---|---|
| Gross | £90,000 |
| Income tax | £23,432 |
| NI (Class 1 employee) | £3,811 |
| Take-home | £62,757 |
Pension contributions sit on top. With 5% salary sacrifice plus a 5% employer match, £9,000/year accumulates in the pension. The £4,500 sacrifice reduces income tax and NI by roughly £1,900 — but cash-in-hand drops by the sacrificed amount.
Effective rate: ~30%. Marginal rate: 42% (40% income tax + 2% NI — inside the higher-rate band, below the taper zone).
Path B: the contractor (outside IR35)
Gross billings run through the company first. The textbook-efficient structure:
- Company pays the director a salary at the personal-allowance threshold (£12,570) — deductible for corporation tax, covered personally by the personal allowance.
- Corporation tax on the remaining profit.
- The director extracts the rest as dividends — first £500 is the dividend allowance, then dividend bands at 8.75% / 33.75% / 39.35%.
| Item | Amount |
|---|---|
| Gross billings | £132,000 |
| Company expenses | £6,000 |
| Director salary | £12,570 |
| Profit before corporation tax | £113,430 |
| Corporation tax (25% headline; marginal relief applied — see below) | £26,309 |
| Profit after corporation tax | £87,121 |
| Dividend extracted | £87,121 |
| Dividend tax | £19,935 |
| Take-home (salary + net dividend) | £79,756 |
Calculation: £113,430 × 25% − (3/200 × (£250,000 − £113,430)) = £28,358 − £2,049 = £26,309. 26.5% is the marginal rate on each pound between £50k and £250k, not the effective rate on the whole profit.
A single-director company normally cannot claim Employment Allowance, so ~£1,136 of employer NI is owed on the £12,570 salary (deductible against profits, lowering CT by ~£300). Net effect on the headline gap is small; some accountants therefore advise paying only up to the £5,000 secondary NI threshold and topping up with dividends.
About £17,000 more than the employee on the headline numbers — but on a higher gross engagement value. Three things change the picture.
Corporation tax stopped being flat in 2023
Pre-April 2023, corporation tax was a flat 19%. Now it ramps from 19% to 25% with a marginal-relief band between £50k and £250k of profits — meaning each marginal pound in that band is taxed at ~26.5%. The contractor above pays roughly £4,800 a year more in CT than the same profit would have attracted under the pre-2023 regime.
IR35 status
If the engagement is inside IR35, the contractor is effectively taxed like an employee on the day rate, with the limited-company structure giving very little back. Since April 2021, for medium and large private-sector clients, the client decides the IR35 status. Public sector has worked this way since 2017.
A 2026 reality: many engagements that were outside IR35 in 2020 are inside today. Path B’s headline number assumes outside-IR35 — that assumption needs verifying before it is relied on.
Costs the headline misses
The £17,000 gap above does not include:
- Employer pension match — the employee’s 5% match is £4,500/year of pension contributions. A contractor can make employer pension contributions from the company (very efficient: no CT, no income tax, no NI, no dividend tax), but only when actively configured.
- Holiday and sick pay — the employee gets ~28 paid days/year without billing. Two weeks of contractor illness is £6,000+ in lost billings.
- Unbillable time — BD, admin, accountant fees (£1–2k/year for a small Ltd), insurance. Typically 5–10% of gross time.
- Benefits in kind — private medical, life cover, share schemes. Can be worth £3–8k/year to an employee.
- Employment protection — notice periods, redundancy, statutory rights.
Adjust for those and the gap can narrow substantially — and in some cases reverse.
When each path is mechanically more efficient
The maths favours employment when:
- The engagement would be deemed inside IR35 either way.
- The employer offers strong pension match or share schemes.
- Day rate would land below £400/day after unbillable time.
The maths favours contracting when:
- The engagement is reliably outside IR35.
- Day rate is north of £600 with consistent billing.
- Pension contributions are made aggressively from the company.
What this does not tell you
The numbers above describe how the tax flows — not whether contracting is the right choice. Running a one-person company carries time, paperwork, and cash-flow obligations that do not show up in any take-home calculation. The maths tells you whether the engagement pays enough to make those obligations worth taking on. Run both paths through the calculator with your own day rate and PAYE comparison before you decide.