How Income Tax works for both
The first thing to understand is that Income Tax does not care whether you are employed or self employed. Everyone gets the same personal allowance of £12,570, which is the amount you can earn before any Income Tax is due. Above that, the basic rate of 20% applies up to £50,270, the higher rate of 40% applies up to £125,140, and the additional rate applies above that level.
So an employee earning £40,000 and a sole trader with £40,000 of taxable profit face exactly the same Income Tax bill. The difference is in how the income is measured and how it is collected. An employee has tax deducted automatically through PAYE every payday. A sole trader works out their profit after expenses, reports it on a Self Assessment return, and pays the bill directly to HMRC. If you want to see the full figure for your own situation, our guide on how much tax you will pay when self employed goes through it step by step.
The word that matters for the self employed is profit. You are taxed on what is left after allowable business costs, not on your total income. That single fact is where a lot of the planning, and a lot of the confusion, comes from.
Where National Insurance changes things
National Insurance is where employees and the self employed genuinely part ways. Employees pay Class 1 National Insurance at 8% on earnings between the threshold and the upper limit, then 2% above that. The self employed pay Class 4 National Insurance at 6% on profits between the threshold and the upper limit, then 2% above that.
That lower main rate, 6% against 8%, is one reason the self employed can keep more of each pound in the middle band. It is not a loophole, it reflects the fact that the self employed do not build up the same entitlements through their contributions. You can read the detail in our explainer on National Insurance for the self employed, which also covers how the thresholds interact with profit.
It is worth remembering that National Insurance is collected differently too. For an employee it comes out automatically alongside Income Tax. For the self employed, Class 4 is calculated on the same Self Assessment return and paid at the same time as the Income Tax bill, which means it lands as one combined payment rather than disappearing quietly each month.
A worked example
The same £40,000, two different routes
Priya is offered the same role two ways: as an employee on a £40,000 salary, or as a self employed contractor invoicing £40,000 with very few expenses. As an employee, she pays 20% Income Tax on the slice above £12,570 and Class 1 National Insurance at 8% on earnings above the threshold, all deducted through PAYE before she sees a penny. She also receives holiday pay, sick pay and employer pension contributions on top.
As a contractor with £40,000 of profit, her Income Tax is identical, but her National Insurance is Class 4 at 6% rather than 8% on the equivalent band, so her National Insurance bill is lower. On paper she keeps slightly more. The catch is that none of the £40,000 includes paid holiday, sick pay or an employer pension, so she has to fund those herself and set money aside for the tax bill that arrives in one lump on 31 January rather than being spread across the year.
The headline is that the contractor route leaves a little more in cash terms on the same figure, mainly through the lower National Insurance rate and the ability to deduct expenses. But once you value the holiday, sick pay and pension that the employee receives for free, the gap narrows considerably and can reverse. The right answer depends on how you weigh cash today against security and benefits.
What each side can claim
This is the area where the self employed have a real advantage, and where employees are quite restricted. The self employed can deduct allowable business expenses from their income before tax is worked out. That includes things like stock, tools, software, professional fees, business travel and a share of home running costs. Our overview of allowable expenses for Self Assessment sets out what counts and what does not.
Employees, by contrast, can only claim a narrow set of work expenses, usually costs they are obliged to pay for their job and that the employer does not reimburse. There is no equivalent of writing off a laptop, a portion of the broadband or mileage in the same flexible way.
The self employed should know about two specific reliefs. The first is the trading allowance of £1,000: if your self employed income for the year is £1,000 or less, you may not need to report it at all, and if it is higher you can choose to deduct the £1,000 instead of your actual expenses. The second is mileage, claimed at 45p a mile for the first 10,000 business miles in the year and 25p a mile after that, which is often simpler than tracking every fuel and running cost.
- Employees get holiday pay, statutory sick pay and employer pension contributions, plus a stable monthly net figure.
- The self employed get expense deductions, the trading allowance, mileage at set rates and more control, but no paid time off and no employer pension.
Common mistakes
The biggest mistake people make is comparing gross figures. A £40,000 salary and a £40,000 contract are not the same thing, because the salary quietly includes paid holiday, sick cover and a pension top up, while the contract does not. Always compare like with like by adding the value of those benefits back when you look at an employed offer.
A second common error is forgetting that the self employed pay their tax later but all at once. PAYE spreads the pain across the year. Self Assessment lands the whole Income Tax and Class 4 bill on 31 January, often alongside a payment on account towards the next year, which catches a lot of first year sole traders by surprise.
A third mistake is assuming you must choose between sole trader and limited company purely on tax. The decision also turns on liability, admin and how you take money out. Our comparison of sole trader versus limited company covers that wider picture rather than tax alone.
What you should do
Start by being honest about what each option really gives you. If you are weighing an employed role against self employment on similar money, build a simple side by side: same income, then add the value of holiday, sick pay and pension to the employed side, and subtract the expenses and lower National Insurance from the self employed side.
If you go self employed, get into the habit of setting money aside for tax from day one, keep clean records of your income and expenses, and diarise the 31 January deadline. Knowing the rates is one thing, but cash flow is what trips people up.
If you would like the figures checked properly for your circumstances, we can model both routes and show you the real take home difference. You can start your quote or have a quick chat with us first using our book a call page.
A clear comparison of how employees and the self employed are taxed, what each can claim, and how the same income leaves you with a different take home pay.
Frequently asked questions
Do the self employed really pay less tax than employees?
Not on Income Tax, which is identical for both. The self employed often pay slightly less National Insurance, because Class 4 starts at 6% against the employee rate of 8%, and they can deduct business expenses that employees cannot. But once you account for the holiday pay, sick pay and employer pension that employees receive, the overall position is much closer and can favour the employee.
What National Insurance does each one pay in 2026/27?
Employees pay Class 1 National Insurance at 8% on earnings above the threshold and 2% above the upper limit. The self employed pay Class 4 National Insurance at 6% on profits above the threshold and 2% above the upper limit. Income Tax rates are the same for both, with the personal allowance at £12,570.
Can employees claim expenses like the self employed?
Only in a very limited way. Employees can claim certain costs they are required to pay for their job and that are not reimbursed by the employer, but there is no broad ability to deduct things like a laptop, a share of broadband or mileage. The self employed have far more scope, including the £1,000 trading allowance and mileage at 45p then 25p a mile.
When do the self employed actually pay their tax?
Through Self Assessment. The online filing and payment deadline is 31 January after the end of the tax year, with payments on account often due on 31 January and 31 July. Unlike PAYE, which spreads tax across the year, the self employed pay in larger lump sums, so setting money aside in advance is essential.
How do I decide between employed and self employed work?
Compare like with like. Take the same income figure, then add the cash value of holiday, sick pay and pension to the employed side and factor in expenses and the lower National Insurance on the self employed side. The best choice depends on whether you value cash now or stability and benefits. We are happy to model both for you.