You've just been told a contract is "inside IR35", and your first thought is simple: how much smaller is my pay packet going to be? It's a fair question, and the honest answer is that it depends on your rate, but the hit is real and worth understanding before you sign.
This guide explains what inside IR35 actually means, who decides it, and how it changes the tax and National Insurance you pay. We'll walk through an illustrative 2025/26 example so you can see the numbers, then give you clear, practical steps to make the best of it.
It's written for limited company contractors and freelancers working through a personal service company. If you've ever felt the rules were deliberately confusing, you're not alone. Let's make them plain.
What does "inside IR35" mean?
IR35 is the nickname for the off-payroll working rules. They exist to catch people who work like employees but bill through their own company to pay less tax.
When a contract is "inside IR35", HMRC treats you as employed for tax purposes, even though you're trading through your own limited company. The point of the rules is that you should pay broadly the same Income Tax and National Insurance as an employee doing the same job would.
"Outside IR35" means the opposite. Your engagement is judged to be a genuine business-to-business arrangement, so you can pay yourself in the usual tax-efficient mix of a modest salary plus dividends.
There are actually two sets of rules. The original intermediaries legislation (Chapter 8) still applies when your client is a small business in the private sector, and there your own company works out the status and the tax. The newer off-payroll working rules (Chapter 10), reformed in the public sector in 2017 and the private sector in 2021, shift that job to the client and the fee-payer. Which set applies changes who does the sums, but the core idea, paying employment-level tax, is the same.
Who decides whether you're inside IR35?
It depends on your client.
If your client is a medium or large business, or any public sector body, the client decides your status under the off-payroll rules. They must give you a status determination statement (SDS) setting out the decision and the reasons for it. In HMRC's words, they "should produce a status determination statement (SDS) including the reasons for their determination."
If your client is a small business in the private sector, the responsibility sits with your own intermediary instead. Your limited company decides whether the rules apply and accounts for any tax due.
A company counts as small for these purposes when it meets at least two of three Companies Act tests. For financial years beginning on or after 6 April 2025, those tests are turnover of no more than £15 million, a balance sheet total of no more than £7.5 million, and no more than 50 employees on average. Below that, your client is small and the decision stays with you.
Clients and fee-payers often use HMRC's Check Employment Status for Tax (CEST) tool to reach a view. The result can be used as a valid status determination statement, although CEST is guidance, not the final word in law.
How does inside IR35 affect your take-home pay?
Here's the part that hits your bank balance.
When you're inside IR35 under the off-payroll rules, the fee-payer becomes your "deemed employer". Before the money reaches your company, they "must deduct Income Tax and employee National Insurance contributions from fees paid to the worker's intermediary", and they also pay employer National Insurance and the Apprenticeship Levy where it applies.
In plain terms, your contract income is taxed through PAYE like a salary. You lose the ability to leave profit in the company and draw lower-taxed dividends, which is where a lot of a contractor's tax efficiency normally comes from.
One quirk worth knowing: a deemed employer does not deduct student loan repayments. If you have a student or postgraduate loan, you sort that out through Self Assessment.
A note on the old 5% allowance. Under the original Chapter 8 rules, your company could deduct a flat 5% of fees for running costs when working out the deemed payment. That 5% allowance is not available where the client applies the off-payroll rules (Chapter 10), so most contractors with medium or large clients can't use it.
Worked example: inside IR35 on a £60,000 contract
Illustrative example. Sam is a limited company IT contractor. A medium-sized client determines Sam's 12-month contract is inside IR35. The deemed employment payment from the engagement works out at £60,000 for 2025/26, taxed through PAYE. Sam has the standard tax code and no student loan. These are employee-side deductions only; the employer National Insurance is paid by the deemed employer on top.
| Step | Calculation | Amount |
|---|---|---|
| Deemed employment payment | Gross for the year | £60,000.00 |
| Personal Allowance | Tax-free band | £12,570.00 |
| Taxable income | £60,000 − £12,570 | £47,430.00 |
| Income Tax at basic rate | £37,700 × 20% | £7,540.00 |
| Income Tax at higher rate | £9,730 × 40% | £3,892.00 |
| Total Income Tax | £7,540 + £3,892 | £11,432.00 |
| Employee NIC, main rate | (£50,270 − £12,570) × 8% | £3,016.00 |
| Employee NIC, above UEL | (£60,000 − £50,270) × 2% | £194.60 |
| Total employee NIC | £3,016 + £194.60 | £3,210.60 |
| Take-home pay | £60,000 − £11,432 − £3,210.60 | £45,357.40 |
So Sam keeps about £45,357 of the £60,000, with roughly £14,643 going in Income Tax and employee National Insurance. The exact figure varies with your tax code, pension contributions and any expenses the rules still allow, but this shows the shape of it.
The Personal Allowance, the basic rate band of £37,700, the 20% and 40% Income Tax rates, and the 8% and 2% employee National Insurance rates and thresholds all apply for 2025/26. If you'd like to model your own rate, our take-home pay calculator does the heavy lifting.
What factors decide your IR35 status?
Status isn't decided by a job title or by what the contract calls you. It's decided by how the working relationship actually operates. Three tests do most of the work.
Control
How much say does the client have over what you do, how you do it, and when and where you do it? The more they direct you like an employee, the more it points inside IR35.
Right of substitution
Could you send a qualified substitute to do the work in your place, with the client having no genuine right to refuse? A real, unfettered right of substitution is a strong pointer to being outside IR35, because it shows the client is buying a service, not you personally.
Mutuality of obligation
Is the client obliged to offer you ongoing work, and are you obliged to accept it? That rolling expectation looks like employment. A defined project with a clear end looks more like a business engagement.
Other factors feed in too: who carries the financial risk, who provides the equipment, whether you're paid per project rather than a fixed wage, and whether you genuinely work for multiple clients. No single factor decides it; HMRC and the courts look at the overall picture.
How can you survive being inside IR35?
Inside IR35 isn't the end of contracting. It just means you plan differently.
- Read the SDS and check it. If your client got the determination wrong, you can challenge it. The reasons in the statement are your starting point.
- Use a pension. Employer pension contributions are one of the few genuinely tax-efficient levers left to you inside IR35, and they reduce the income taxed through PAYE.
- Get the contract reviewed. An independent review of the contract and your actual working practices can confirm a borderline role really is inside, or give you grounds to push back.
- Price it in. If a role is inside IR35, factor the lower net pay into the rate you accept. Many contractors quote a higher day rate for inside-IR35 work to offset the tax.
- Keep your company tidy. Even when one contract is inside, you may have outside-IR35 work elsewhere, so clean records matter. Good self-assessment support keeps the two streams straight.
The mistake we most often see in practice is contractors signing an inside-IR35 contract without modelling the net pay first, then getting a shock on the first payslip. A few minutes of planning avoids that.
Want a second opinion on your status and the most tax-efficient way to structure your work? Our tax advisory team helps contractors do exactly this. Book a free 20-minute call with a Zmartly accountant and we'll talk through your contract and your numbers.
For more on building a resilient contracting business, see our hub for IR35 contractors and our wider guidance for limited company contractors.
Frequently asked questions
Is inside IR35 the same as being an employee?
Not quite. You're treated as employed for tax, so you pay Income Tax and National Insurance through PAYE on that income. But you don't usually get employment rights like holiday pay, sick pay or redundancy from the client, which is why many contractors feel they get the worst of both worlds.
Do I pay more tax inside IR35 than outside?
Generally yes. Outside IR35 you can draw a low salary plus dividends and leave profit in your company, which usually means less National Insurance overall. Inside IR35 your contract income is taxed like a salary, so your take-home pay is lower for the same gross figure.
Can I still claim expenses inside IR35?
Far fewer than before. Under the off-payroll rules, most travel and subsistence to a single workplace is treated like an employee's commute and isn't allowable. The old 5% flat allowance for running costs doesn't apply where the client operates the off-payroll rules. Pension contributions remain one of the few effective reliefs.
Who pays the tax when I'm inside IR35?
If the off-payroll rules apply, the fee-payer (your "deemed employer", often the agency or the client) deducts your Income Tax and employee National Insurance before paying your company, and pays employer National Insurance on top. If your client is small, your own company works out and pays the tax instead.
Can I challenge an inside IR35 decision?
Yes. If a medium or large client determines you're inside IR35 and you disagree, you can use the client's status disagreement process. The status determination statement must give the reasons for the decision, and an independent review of your contract and working practices can support a challenge.
