The headline numbers
A contractor at £500/day for 220 days has a turnover of £110,000. Operating through a limited company outside IR35, with the standard salary-and-dividend split (£12,570 salary, rest as dividends), take-home is approximately £69,656 a year — significantly more than the same contract inside IR35.
| How the limited-company maths works | Amount |
|---|---|
| Annual turnover (£500 × 220 days) | £110,000 |
| Less: Business expenses (accountant, software, professional indemnity, training, etc.) | −£5,000 |
| Profit before salary | £105,000 |
| Less: Director's salary (£12,570 — uses personal allowance, no NI as below ST) | −£12,570 |
| Profit before Corporation Tax | £92,430 |
| Less: Corporation Tax (19% small profits + 26.5% marginal) | −£20,744 |
| Distributable profit (available as dividends) | £71,686 |
| Less: Dividend tax (8.75% / 33.75% on amount above £500 allowance and PA) | −£14,600 |
| Take-home (salary + dividends − dividend tax) | £69,656 |
Effective deduction from turnover: 36.7%. The dividend vs salary calculator models other splits (e.g. higher director's salary to use the NI primary threshold, lower-rate-only dividends, etc.) and shows whether the standard split is optimal for any given turnover.
Why the salary is set at £12,570
Three constraints converge on £12,570 as the optimal director's salary for most one-person limited companies:
- Personal allowance: the first £12,570 of income is tax-free.
- NI primary threshold: employee NI starts at £12,570. Salary at exactly this level pays £0 employee NI.
- NI secondary threshold (employer): at £5,000 in 2026/27. Salary above this triggers employer NI at 15%, but for a one-person company the £10,500 Employment Allowance offset means employer NI on a £12,570 salary is fully cancelled (until the rules change again).
Setting salary higher than £12,570 means paying employee NI plus tax on the extra slice. Setting it lower means under-using the personal allowance. Salary at £12,570 captures full PA and NI credit toward State Pension qualifying years, with zero income tax and zero employee NI.
Some contractors set salary at the NI Primary Threshold (£12,570) precisely; others go marginally higher to a "tax-efficient" point factoring in personal circumstances. The director extraction planner models the optimal split for each turnover band.
Corporation Tax — the marginal rate trap
Corporation Tax has three tiers in 2026/27:
- Small profits rate: 19% on profits up to £50,000.
- Marginal relief: effective 26.5% on profits between £50,000 and £250,000.
- Main rate: 25% on profits above £250,000.
For a one-person consultancy with turnover £80k-£200k, the marginal 26.5% tier is the dominant rate. This is materially higher than the 19% rate that applied before April 2023 and changes the salary/dividend optimisation.
Note: contractors with multiple companies should be aware of the "associated companies" rule — running two companies splits the £50,000 small profits threshold across them, pulling more of the profit into the 26.5% marginal tier. Not usually optimal unless there's a non-tax reason for the structure.
The four decisions for an outside-IR35 contractor
- Pension contributions through the company. Employer pension contributions from a limited company are corporation-tax-deductible and not subject to Annual Allowance taper rules in the way personal contributions are. £20,000 of company pension contribution costs the company about £14,700 net of corporation tax saving. This is the single most powerful tax-planning lever available outside IR35. The pension annual allowance calculator checks the £60,000 limit.
- Use the dividend allowance and savings allowance fully each year. £500 of dividend income tax-free, £1,000 of savings interest at 0% (basic rate). Spread investments and savings across both partners' accounts where applicable.
- Keep IR35 evidence current. Substitution clauses, control evidence, mutuality of obligation arguments, multiple concurrent clients, business insurance, business website, business cards. Build the file as you go — if HMRC challenges the status determination years later, you need the evidence trail.
- VAT-register at £85,000 turnover threshold (or earlier, on Flat Rate Scheme). Once turnover exceeds £85k in any rolling 12-month period, VAT registration is mandatory. The Flat Rate Scheme (16.5% rate for "limited cost businesses" — most one-person consultancies fall here) is operationally simpler than standard VAT but rarely tax-advantageous now. The VAT calculator models the comparison.
The most common mistake
Drawing dividends faster than the company has distributable profit. Dividends are paid from accumulated post-tax retained profit, not from cash in the bank account. If you withdraw more than the company has earned (after corporation tax), the excess becomes a director's loan — which triggers a Section 455 corporation tax charge of 33.75% on the outstanding balance after 9 months. Many contractors stumble into this in the first year of trading.
The fix: maintain a simple monthly P&L, run the dividend declaration formally (board minute + dividend voucher), and never declare a dividend you haven't actually earned. Most decent contractor accountants automate this; if yours doesn't, get a new accountant.
Sources
HMRC Corporation Tax rates · Dividend tax · Employment Allowance.