Guide
Self-employed vs employed: the real difference
People leaving employment usually assume self-employment is far more tax-efficient. The headline rates say otherwise. This guide compares identical income under both regimes, shows where the genuine advantages actually sit, and covers the two things that catch newly self-employed people out: payments on account and Making Tax Digital.
The same income, both ways
Compare an employee on a £50,000 salary with a sole trader making £50,000 of taxable profit, both in England with the full personal allowance and no pension contributions.
| Line | Employee | Sole trader |
|---|---|---|
| Income tax | £7,486 | £7,486 |
| National Insurance | £2,994 | £2,246 |
| Left after tax | £39,520 | £40,268 |
The gap is £749, and it comes entirely from Class 4 National Insurance being charged at 6% rather than the employee's 8% in the main band. Above £50,270 both pay 2%, so the advantage stops growing. Class 2 adds nothing to the bill: once profits reach the small profits threshold of £7,105 it is treated as paid, which protects the qualifying year for state pension purposes at no cost.
What the comparison leaves out
£749 is nowhere near enough to explain why self-employment can be either much better or much worse than employment. The real differences sit outside the tax tables.
- Employer pension contributions. A typical employer contributes at least 3% of qualifying earnings, and many contribute far more. A sole trader funds their own pension entirely, though contributions are still relieved against income tax.
- Paid leave.An employee's salary covers 28 days of statutory holiday. A sole trader who takes four weeks off simply invoices nothing for four weeks.
- Sick pay and parental pay. Statutory sick pay and statutory maternity pay are not available to the self-employed, although Maternity Allowance may be.
- Allowable expenses. The one genuine structural advantage. An employee can deduct almost nothing; a sole trader deducts every cost incurred wholly and exclusively for the business before tax is calculated at all.
Expenses, done properly
Expenses reduce profit, and profit is what is taxed. A sole trader with £60,000 of turnover and £10,000 of genuine costs is taxed on £50,000, not £60,000 - so those costs are effectively bought at 72p in the pound in the basic rate band, or 58p in the higher rate band.
Common allowable costs include stock and materials, tools and equipment, software subscriptions, professional indemnity insurance, accountancy and legal fees, business travel and accommodation, advertising, bank and finance charges on business accounts, and training that maintains existing skills. Home working can be claimed either through HMRC simplified flat rates or by apportioning actual household costs by rooms and hours.
Two rules do most of the work. The cost must be wholly and exclusively for the business, and anything with private use must be apportioned honestly. A laptop used half for the business is a half claim, not a full one. For very small side incomes the £1,000 trading allowance can be claimed instead of expenses, and if gross income is under £1,000 there is usually nothing to report at all. You cannot claim both the allowance and actual expenses.
Payments on account: the first-year shock
Employees pay tax as they earn. The self-employed pay it in arrears, and then in advance, which produces a brutal first bill.
Worked example
A sole trader makes £50,000 of profit in 2026/27. The tax and Class 4 National Insurance bill is £9,732. That is due by 31 January 2028 - but so is the first payment on account for 2027/28, which is half of it, £4,866. The January payment is therefore £14,598. A second payment on account of £4,866 follows on 31 July 2028. In the space of six months, £19,464 leaves the bank against a £9,732 liability.
It balances out from the second year onwards, because each January bill is reduced by the payments already made. But the first one catches almost everybody, and the only defence is to set money aside from day one. Payments on account do not apply if your last bill was under £1,000, or if more than 80% of your tax was collected at source - see gov.uk on payments on account.
Making Tax Digital changes the admin
Since April 2026, sole traders and landlords with qualifying income over £50,000 have had to keep digital records and file quarterly updates rather than one annual return. The £30,000 threshold follows in April 2027 and £20,000 in April 2028. Qualifying income is gross turnover before expenses, which means a trader with £55,000 of turnover and £30,000 of profit is in scope even though their profit is well under the threshold.
Practically, that means bookkeeping software, four filings a year plus the annual return, and much less scope to reconstruct a year of records the week before 31 January. Check whether you are mandated with the MTD checker, and see MTD quarterly updates explained for what each filing contains.
Deciding between the two
The tax difference on identical income is small. The decision usually turns on rate, not regime: whether the day rate or fee you can charge exceeds the salary plus employer pension plus paid leave you would otherwise get, with enough margin to cover unpaid holiday, quiet months and your own sick pay. A common rule of thumb is that a contract rate needs to be materially above the equivalent salary before self-employment leaves you ahead in cash terms.
Run the numbers
Use the take-home pay calculator to see what an employed salary really delivers, and the hourly to salary converter to translate a day rate into a comparable annual figure before deciding.
Common questions
Do the self-employed pay less tax than employees?
They pay the same income tax and slightly less National Insurance. Class 4 is 6% between £12,570 and £50,270 against 8% for employees, so on £50,000 of profit the saving is about £749 a year. Everything else that makes self-employment financially different comes from expenses, employer contributions and the absence of paid leave, not from the headline rates.
What are payments on account?
They are advance payments towards next year's tax bill, each equal to half of the previous year's liability, due on 31 January and 31 July. They do not apply if your last bill was under £1,000 or if more than 80% of your tax was already collected at source. In your first profitable year, the January payment is your whole bill plus the first instalment, which is why it feels so large.
What can I claim as an allowable expense?
Costs incurred wholly and exclusively for the business: stock, tools, software, professional insurance, accountancy fees, business travel, and a proportion of home costs if you work from home. Personal costs are not allowable, and anything with mixed use must be apportioned honestly. If your turnover is very small, the £1,000 trading allowance may be simpler than claiming expenses at all.
Does Making Tax Digital apply to me?
It applies to sole traders and landlords by qualifying income, which is gross turnover from self-employment and property before expenses. Over £50,000 was mandated from April 2026, over £30,000 follows in April 2027 and over £20,000 in April 2028, each based on the tax return from two years earlier.
Figures are for the 2026/27 tax year in England, Wales and Northern Ireland and assume a sole trader rather than a limited company, which is taxed differently. General information, not personal tax or business advice.