Self-employed vs employed: tax compared

Whether you’re thinking of going freelance, taking a contract, or comparing a job offer with self-employment, it helps to know how the tax compares. Income tax works the same way, but National Insurance doesn’t, and there are other differences in how and when you pay. This guide sets them out for the current tax year.

Income tax: the same rules

Income tax is charged on the same basis for employees and the self-employed. Everyone gets the same Personal Allowance of £12,570, which is reduced above £100,000, and the same bands and rates. For the self-employed, tax is charged on your profits: your business income minus allowable expenses.

The difference is how you pay. Employees pay through PAYE each payday. Self-employed people pay through Self Assessment, usually in two payments on account during the year and a balancing payment by 31 January after the tax year ends. GOV.UK’s guide to working for yourself explains how to register and what you need to do.

National Insurance: Class 1 vs Class 4

This is where the big difference lies.

Employees pay Class 1 NI at 8% on earnings between the primary threshold and the upper earnings limit, and 2% above. Their employer also pays 15% on earnings above £5,000.

Self-employed people pay Class 4 NI on profits: 6% between £12,570 and £50,270, and 2% above. There’s no employer NI.

Class 2 contributions are now voluntary for most people. They can be worth paying if your profits are below the small profits threshold of £7,105, because they protect your State Pension record at a low weekly cost of £3.65. GOV.UK’s Self-employed National Insurance rates page has the details.

Worked comparison: £40,000

Compare an employee earning a £40,000 salary with a self-employed person making £40,000 of profit, both in England with no pension or student loan:

• Income tax: the same for both, £5,486.
• National Insurance: the employee pays £2,194 of Class 1. The self-employed person pays £1,646 of Class 4.
• Take-home: the employee keeps £32,320. The self-employed person keeps £32,868, a difference of £549.

The employer also pays about £5,250 of employer NI on the employee’s salary. That’s part of the cost of employing someone, and one reason contract day rates are usually higher than the equivalent salary.

What the comparison leaves out

Take-home pay isn’t the whole picture. Employees get things that the self-employed have to fund themselves:

• Paid holiday, which for a full-time employee is several weeks a year.
• Sick pay and family leave, including Statutory Sick Pay and Statutory Maternity Pay.
• Employer pension contributions under automatic enrolment, often more.
• Employment rights, such as protection from unfair dismissal and redundancy pay.

The self-employed also have costs that employees don’t, such as equipment, insurance, accountancy fees and periods without work. On the other hand, they can deduct allowable business expenses from their profits, which reduces both income tax and Class 4 NI.

When comparing a contract rate with a salary, a common approach is to work out the annual income from the contract after allowing for unpaid holiday and gaps between contracts, then deduct expenses, and only then compare take-home pay.

Expenses and allowances

Self-employed people can deduct allowable business expenses from their income before working out tax and Class 4 NI. Allowable expenses are costs incurred wholly and exclusively for the business, such as stock, equipment, business travel, professional insurance, accountancy fees and a share of household bills if you work from home. Employees can only claim tax relief on a narrower set of expenses that their employer doesn’t reimburse.

If your expenses are low, you can use the trading allowance instead, which lets you earn a small amount of business income tax-free without claiming expenses. GOV.UK’s guide to expenses if you’re self-employed lists what you can claim.

Registering and deadlines

If you start working for yourself, you need to register for Self Assessment by 5 October after the end of the tax year in which you started. You then file a tax return each year and pay any tax owed by 31 January. If your tax bill is above a certain level, you also make two payments on account towards next year’s bill, in January and July. Setting aside a share of each payment you receive makes the bill easier to manage.

Pensions when self-employed

Self-employed people don’t get employer contributions, so pension saving is down to you. Contributions to a personal pension get tax relief at source, with basic-rate relief added by your provider, and higher-rate taxpayers claim the rest through Self Assessment. Our guide to pension tax relief explains how. Salary sacrifice isn’t available, as there’s no salary to sacrifice.

Student loans when self-employed

If you have a student loan, repayments are worked out on your total income through Self Assessment, rather than each payday. See our guide to student loan repayments.

Running a limited company

Some contractors and freelancers work through their own limited company instead. The company pays corporation tax on its profits, and you can take money out as a mix of salary and dividends, which are taxed at different rates. The dividend vs salary calculator compares the options. It’s worth getting professional advice before setting up a company, and taking care with the IR35 rules if you work like an employee for a client.

Compare your own figures

Our self-employed vs employed calculator compares take-home pay for the same income as an employee and as a sole trader. For more on employee NI, see our guide to National Insurance, and for the income tax bands, how income tax works.