Outside IR35 in 2026/27: The Complete Tax Strategy for Limited Company Contractors

Author: TJ Smith

Outside IR35 remains one of the best tax positions available to UK workers. It is also one of the most under-used, because most contractors are running on default settings: salary at the personal allowance, rest in dividends, pension ignored.

The default is fine. Proper planning is better. For a contractor earning £120,000 a year through their PSC, the difference between default and structured can be £8,000 to £15,000 a year. Compounded over a contracting career, that is a material number.

This guide covers the complete outside IR35 tax planning strategy for 2026/27: the salary question, the dividend question, the pension question most contractors miss, and two worked examples showing what planned versus unplanned looks like in real money.

The foundation: confirming you are genuinely outside IR35

Everything else in this guide assumes your IR35 status is correct. If you are actually inside IR35 but filing as outside, you are exposed to back-tax, interest, and penalties, and the strategy below does not apply.

The key tests are:

Substitution: Do you have a genuine right to send a qualified substitute to do the work? If your contract includes a substitution clause but you have never exercised it and the client would not genuinely accept one, the clause carries limited weight.

Control: Does the client direct what you do and how you do it, or do you decide how to deliver the outcome? True outside IR35 contractors determine their own method and working hours.

Mutuality of obligation: Is there an expectation of ongoing work in both directions? Outside IR35 contractors have a clear project or deliverable, not an open-ended employment-like relationship.

Keep evidence. HMRC can challenge a determination. Documents showing client communications, working arrangements, and actual practice are worth more than contract wording that does not reflect reality.

For medium and large clients, they issue a Status Determination Statement before work begins. If you disagree with it, challenge it formally in writing and document the challenge.

The salary question: £12,570 in 2026/27

For most single-director contractor companies, the optimal salary for 2026/27 is £12,570.

Here is the logic:

At £12,570: - Employee income tax: £0 (personal allowance covers it exactly) - Employee NI: £0 (primary threshold is £12,570) - Employer NI: (£12,570 minus £5,000) x 15% = £1,135.50

The company pays £1,135.50 in employer NI. But the salary and the employer NI are both deductible from company profit:

• Corporation Tax saving at 19%: (£12,570 plus £1,136) x 19% = £2,604
• Net cost to company of the salary: £11,102

You receive £12,570 take-home for a net company cost of £11,102. That compares favourably to taking the same amount as a dividend, where the company would pay 19% Corporation Tax on the profit first (£12,570 would require £15,519 of pre-tax profit, costing £2,949 in CT, leaving £12,570 to distribute, then you pay 8.75% dividend tax on it, netting £11,471 in your pocket on £15,519 of profit).

The salary of £12,570 is marginally more efficient than paying yourself the same amount in dividends. More importantly, it maintains a salary record for pension purposes and, in some cases, mortgage applications.

Single-director companies cannot claim the Employment Allowance. The £10,500 Employment Allowance is not available to companies where the sole employee is also a director. If you have a second genuine employee, the position changes.

The dividend strategy: filling bands, not draining reserves

After salary, dividends are the main extraction route. The key threshold to manage is the jump from the 8.75% basic rate to the 33.75% higher rate.

2026/27 dividend thresholds: - £500 dividend allowance at 0% - 8.75% up to total income of £50,270 - 33.75% from £50,271 to £125,140 - 39.35% above £125,140

After a £12,570 salary, you have £37,700 of basic rate band remaining. Combined with the £500 dividend allowance, you can take £38,200 in dividends before any higher-rate dividend tax applies.

The combined effective rate on those dividends (19% CT on company profits plus 8.75% personal dividend tax) is approximately 26.6%. That is the cheapest extraction available after pension.

Above the basic rate band, extraction becomes expensive. At 33.75% dividend tax on post-CT profits, the combined rate rises to approximately 46.3%. At this level, the question is not how to extract more efficiently, it is whether to extract at all, or whether pension contributions and retained profits are better options.

The pension angle: the calculation most contractors ignore

Employer pension contributions from your PSC are: - Corporation Tax deductible (saving 19% or 25% depending on your CT rate) - Not subject to employer NI - Not subject to employee NI - Not subject to income tax at the time of contribution - Not counted as your personal income for adjusted net income purposes

The annual allowance is £60,000 (2026/27), which can be increased by unused allowance carried forward from the previous three years (if you were a member of a pension scheme).

Here is what this means in practice:

A £20,000 employer pension contribution from your PSC: - Reduces company profit by £20,000 - Saves Corporation Tax at 19%: £3,800 - Net cost to company: £16,200 - Pension receives: £20,000

Compare to taking £20,000 as a higher-rate dividend: - Company profit: £20,000 - CT at 19%: £3,800 - Post-CT available as dividend: £16,200 - Personal dividend tax at 33.75%: £5,468 - Take-home: £10,732

Pension: £20,000 in the fund for a company cost of £16,200. Dividend: £10,732 in your pocket for a company cost of £20,000 (CT paid on the gross profit).

The pension is not just more tax-efficient on the extraction. It is more efficient in absolute terms: more money lands in the pension than lands in your pocket from the dividend at this tax rate. The pension money also grows tax-free, and when you draw it in retirement, 25% is tax-free and the remainder is taxed at your marginal rate then.

For contractors regularly extracting at the higher-rate band, the pension is not a nice-to-have. It is the most efficient thing you can do with surplus profit.

Worked example 1: contractor on £90,000 day-rate income, no planning

Annual day rate income: £90,000 to the company

No planning: takes £90,000 as salary

Company position: - Salary: £90,000 - Employer NI: (£90,000 minus £5,000) x 15% = £12,750 - CT deduction on salary plus employer NI: (£90,000 plus £12,750) x 19% = £21,423

Director (personal): - Gross salary: £90,000 - Income tax: £12,570 at 0%, £37,700 at 20% (£7,540), £39,730 at 40% (£15,892) = £23,432 - Employee NI: £0 to £12,570, £37,700 at 8% (£3,016), £39,730 at 2% (£795) = £3,811 - Take-home: £62,757 - Total tax and NI: £40,093 (personal tax plus employer NI)

Worked example 2: same contractor, structured extraction

Same £90,000 income. Structured: salary £12,570, pension £20,000, dividends to fill remaining band

Company position: - Salary: £12,570 (employer NI: £1,136, CT saving: £2,604, net cost: £11,102) - Pension: £20,000 employer contribution (CT saving: £3,800, net cost: £16,200) - Remaining company profit before CT: £90,000 minus £12,570 minus £1,136 minus £20,000 = £56,294 - CT at 19%: £10,696 - Post-CT profit: £45,598

Dividends available: £45,598

Director (personal): - Salary: £12,570, no tax or NI - Dividend allowance: £500 at 0% - Remaining basic rate band: £37,700 at 8.75% = £3,298 (taking £37,700 in dividends) - Remaining dividends (£45,598 minus £500 minus £37,700 = £7,398) at 33.75% = £2,497 - Total dividend tax: £5,795

Take-home (salary plus dividends minus tax): £12,570 plus £45,598 minus £5,795 = £52,373 Plus £20,000 in pension Total effective remuneration: £72,373

Versus £62,757 take-home from the salary-only approach.

That is a £9,616 improvement per year. The actual cash in pocket is less (£52,373 versus £62,757), because £20,000 has gone into the pension rather than being paid in additional salary. But the pension money is the contractor's money, growing tax-free. The total effective remuneration is £72,373 versus £62,757.

And the total tax and NI cost in the structured approach is: £1,136 (employer NI) plus £10,696 (CT on remaining profit) plus £5,795 (dividend tax) = £17,627. Versus £40,093 in the unplanned version.

The tax saving is £22,466 per year on the same £90,000 of income.

Part of that saving (£20,000) goes into the pension rather than the pocket. The rest (approximately £2,466) is a direct cash improvement. But the pension contribution at the 19% CT saving cost only £16,200 to fund a £20,000 pension input.

What to do between contracts

Contract gaps are a normal part of contracting life. During gaps:

• Dividends from retained profits in your basic rate band carry no NI and are taxed at only 8.75%
• Employer NI is not payable on dividends
• There is no pressure to take salary if you are not working

Use contract gaps to draw down retained profits within the basic rate band rather than extracting at higher rates during peak contract periods. This is a deliberate smoothing strategy.

The contractor who is approaching £100,000 personal income

Once your adjusted net income approaches £100,000, the planning priority changes. Every pound above £100,000 triggers the personal allowance withdrawal at a 60% effective marginal rate.

For a contractor with £110,000 in personal income (salary plus dividends), the marginal rate on that top £10,000 is 60%. A £10,000 employer pension contribution would cost the company £8,100 after CT relief and would completely eliminate that £10,000 from the 60% band, saving £6,000 in personal tax, plus preserving £5,000 worth of personal allowance at 40%, saving another £2,000.

Total saving: £8,000. Net cost of the pension contribution to the company: £8,100. The pension contribution is essentially free.

If you are earning anywhere near £100,000 in personal income from your PSC and you are not making pension contributions, you should have that conversation before the tax year ends.

See if a structured approach is right for you

The examples above are based on a single-director company with no complications. Your actual position will depend on your day rate, contract volume, retained earnings, spouse's income, and other personal factors.

Get a quote for contractor accounting or find out whether Smith & Johnson is a fit for your situation.

Frequently asked questions

What does "outside IR35" mean for my taxes? Outside IR35 means HMRC accepts you are genuinely self-employed for the engagement. You operate through your Personal Service Company (PSC), pay yourself a combination of salary and dividends, and pay Corporation Tax on company profits. You do not pay PAYE income tax and NI on all your earnings as an employee would. The tax saving versus PAYE for the same income can be significant, typically £8,000 to £20,000 per year depending on your earnings.

What is the optimal salary for an outside IR35 contractor in 2026/27? For most single-director contractor companies, £12,570 remains the optimal salary. You use the full personal allowance with no income tax and no employee NI. Employer NI of £1,136 is payable, but the Corporation Tax deduction on salary plus employer NI (at 19%) more than covers it. If your company pays the 25% main rate of Corporation Tax (profits above £250,000), the calculation shifts but £12,570 typically still wins.

How much can I take as dividends outside IR35 in 2026/27? After your £12,570 salary, you have £37,700 of basic rate band remaining (to £50,270 total income). With the £500 dividend allowance, you can take up to £38,200 in dividends at an effective combined rate (CT plus 8.75% dividend tax) of approximately 26.6%. Beyond that, dividends are taxed at 33.75%, and the combined rate rises to approximately 46.3%. Planning extraction to stay within the basic rate band is a significant efficiency gain.

Should outside IR35 contractors use pension contributions? Yes, and most do not use them anywhere near as effectively as they could. Employer pension contributions from your PSC are Corporation Tax deductible, carry no employer NI, no income tax, and no employee NI. The annual allowance is £60,000. For contractors earning above the basic rate band, employer pension contributions are the most efficient extraction route available. Every £10,000 in employer pension contributions costs the company approximately £8,100 after CT relief at 19%.

How do I prove I am outside IR35? Evidence of outside IR35 status comes from three areas: substitution (the genuine right to send a substitute to do the work), direction and control (you decide how you deliver the work, not the client), and mutuality of obligation (no expectation of ongoing work, no obligation to accept work offered). Keep contemporaneous records of your working practices. Document substitution clauses exercised, client communications confirming your autonomy, and the fact you use your own equipment and working methods.

What is the Employment Allowance and can contractor companies claim it? The Employment Allowance reduces an employer's NI liability by up to £10,500 per year. However, companies where the sole employee is also a director cannot claim it. Most single-director contractor PSCs are excluded. If you have a second genuine employee (a spouse on payroll, for example), the allowance becomes claimable, which changes the salary calculation meaningfully.

What happens to my contractor company between contracts? During gaps between contracts, your company can continue to exist and you can pay yourself from retained profits. There is no NI on dividends, so between-contract income from dividends in the basic rate band is taxed at only 8.75%. Keep the company running unless you are certain you will not need it again. Retain profits where possible rather than extracting at higher rates.

Is it worth being outside IR35 at a day rate of £500 versus PAYE at £450? At a day rate of £500 outside IR35 (approximately £115,000 annualised at 230 working days), the tax saving versus PAYE at £115,000 is roughly £12,000 to £18,000 depending on extraction strategy. The £50 per day premium over a PAYE equivalent adds approximately £11,500 per year. So at those numbers, the combination of rate premium and structure means the outside IR35 contractor takes home £23,000 to £30,000 more. The exact numbers depend on your extraction strategy.