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.