Having trouble estimating your tax bill? Tracking your time and billable hours may be the solution to your tax time woes.
Tax time cometh. A bit later this year, at least for Americans, since in light of the coronavirus pandemic, the IRS extended the deadline to file and pay federal income taxes for 2019 to July 15th, 2020, but it comes all the same, as it does every year.
If you’re a freelancer or sole proprietor of a business, or a W-2 employee who needs to keep track of billable hours, and you haven’t already set up a system for tracking your work income, it might be a little late in the game to do so for last year’s taxes. But it’s the perfect time to improve your system for this year’s using Toggl.
First, we’ll cover the key building blocks for managing your business and calculating your income. Then we’ll go over answers to common questions about billable hours and their role in tax prep, having picked the brain of Mark Dissen, owner of Wayfare Accounting, a virtual accounting practice that specializes in international taxation and small business services. (He knows a good bit about preparing taxes all around the world.) And from there, we’ll share some examples of what time tracking with Toggl looks like and how that data can feed into your tax prep process.
Understanding your income (and collecting it)
The idea of taxation is pretty basic: you do work, and some portion of what you make for doing that work is owed to the government of the place you did the work in, so that they can provide services and fund their activities. It’s a necessary part of modern society and can also be a huge pain.
The process of filing and paying taxes is complicated, though it’s made easier if you work for a company that automatically withholds some of your salary in order to cover your taxes. If that’s not true for you, you’ll be responsible for calculating your tax burden throughout the year and regularly making quarterly payments to the government according to what you owe.
But no matter how you’re preparing your taxes—as a freelancer or as an employee—you need to start with having money coming in.
Let’s take on the freelancer example. Freelancers most often charge clients in one of two ways: by billable hours or with a fixed rate per project. (Retainers and other pay structures exist, but are less common).
If you charge by billable hours, you need to track your time closely, using a time tracker like Toggl. If you charge by project, you will probably still track your time, even if that data goes to no audience but yourself, to make sure you’re charging a reasonable rate based on how long the project takes you.
In either tracking methodology, you need to start by having a reasonable hourly rate.
Here’s an easy way to think about creating that:
- Start with your ideal end-of-year salary. This isn’t the only way to begin—and in fact, many freelancers prefer to think not about how much money they need but how much value their work has, and to structure their income planning around quantity of work done versus quantity of hours worked—but I think it’s the best way, at least for someone starting out. Many people go into freelancing in order to have more control over their time, so knowing how much your time is actually worth is a very useful tool to use when weighing the attractiveness of various opportunities.
- Calculate how much you’ll be working, keeping in mind vacations and preferences
- Calculate how much of that work time will be billable hours versus not
- Divide your ideal salary by your likely billable hours to get a baseline sense of your rate
Played out, that process looks like this:
- Let’s say I want to make $70,000 a year. Considering that in the States, a reasonable expectation of the tax burden of a self-employed person is about 30%—broken down into about 15% self-employment tax and 15% income tax—I need to make $91,000 to actually have $70,000 at the end of the year.
- I plan on taking 3 weeks of vacation a year, and let’s plan on an extra 3 weeks in case I get sick or have family obligations, so I’ll work 46 weeks (52 – 6) over the course of the year.
- For those 46 weeks, I want to work no more than 30 hours/week, spread out into five 6-hour days. By the end of the year, I’ll have worked 1,380 hours.
- Of those 1,380 hours, I think about 70% of them will be billable hours (more on this in a moment). The other 30% will be spent invoicing, finding new clients, negotiating contracts, and other non-billable tasks. That means I’ll work 966 billable hours by the end of the year.
- In order to make $91,000 (to, remember, go home with $70,000), while working 46 weeks of the year, while working 30 hours a week, while working on billable tasks 70% of that time, I’d need to charge $94/hour to make my ideal salary.
There you go: my hourly rate. Keep in mind two things about this rate, though: first, it doesn’t take into consideration any of my costs for running a business. If I’m a writer (which, in this example, just like in my real life, I am), my costs are relatively low: word processing software, storage, web hosting, a computer. They’re low enough that I don’t need to increase my hourly rate to cover them. But if you start including advertising and marketing costs, accounting services, office space, tools, health insurance, and other costs associated with doing business, those expenses can build up, and you may need to reconsider your hourly rate.
Second, that hourly rate is dependent on me having enough clients to support the amount of hours I want to work and that my estimations of how much of my time will be billable versus not is accurate. To confirm that both things are true, I’d need to track my hours over time and compare my estimated split to my actual time spent on various tasks.
Doing that double-check is a good idea. Either your estimate will have been right, in which case, pat yourself on the back, or it will have been wrong, in which case you’ll be motivated to streamline your administrative tasks, charge a higher hourly rate, or work more hours in order to get to your ideal income.
When you’re sorting through your time worked and wondering if it’s billable or not, follow these guidelines.
What are billable hours?
These will vary depending on your business and what kinds of projects you do. Per Mark, our accountant extraordinaire, “billable work would be directly related to a client,” which for him would include preparing tax returns and meeting with clients, and non-billable hours would be any time that you’re working but without output that’s directly tied to a client.
Common non-billable tasks that are still necessary for a business include:
- Invoicing clients, paying bills, preparing taxes
- Doing new business development (prospecting new clients)
- Designing and executing marketing plans for your business, including building a website, writing an email campaign, or launching an ads program
- Professional development and training (conferences, courses, certifications)
Is communication time, like time spent responding to emails or on the phone, billable?
It could be, depending on what you’re communicating about. Mark says, “If you’re communicating with a client, then it might be billable. If you’re responding to emails from your boss about the upcoming company retreat, then that would not be billable. In practice, this is pretty tough to actually track because of the sporadic nature of emails.” If regularly find yourself spending five, ten, fifteen minutes on crafting email responses to client, you should start tracking (and billing for) that time, as it does add up. One 10-minute email response per working day for 46 working weeks equals 38 hours a year!
Is travel time billable?
Usually, no, but if you’ve worked it out with your client that they will pay for that time—then yes. Mark explains: “‘Billable’ really just means that the client is directly paying for that time, and so it depends on what the client agrees on ahead of time. For example, one client might agree to pay for the hours you spend driving to their worksite while another client might expect the firm to cover those costs.”
What does a billable hours chart look like?
Check out this example of a Toggl time report that differentiates between billable hours and non-billable hours. I could use this data to determine whether I was falling into my 70% billable versus 30% not ideal time split.
Once you’ve got those billable hours, you need to be able to invoice for them.
If you work for a firm or agency with a centralized billing function, you can just send over your tracked time and let them do their thing. If you are your own boss and also bookkeeper, you can export your time tracking data to populate invoices (Toggl integrates with 100+ tools, including several of the most popular accounting and invoicing programs) and send them directly to clients.
Using past income to project quarterly tax payments
If your country, like the U.S., makes self-employed people send in quarterly tax payments based on their estimated annual income, having tracked-time data will be extremely helpful.
Toggl lets you create reports to look at your tracked time data for any time period you choose. If you go in and pull reports for billable hours worked for the first three months of the year, for instance, you might see a report like this:
Let’s say that you had 250 billable hours for the first quarter of the year. If your business expenses and your business revenue is slated to stay more or less the same over the year, you can calculate your estimated tax burden based on the income you’ll have made (once all your clients pay those invoices!) and go ahead and make that payment.
Looking at real-time data to make those payments helps reduce the risk of being charged penalties for not paying enough as you go. For example, let’s say you’re working more hours this year that you did last year. If you’d used an estimation based on last year’s tax burden, you’ll get to the end of the year and find out that you were underpaying in each quarter. Using real-time tracking keeps you up-to-date on tax obligations and helps you get ahead on those quarterly payments.
Keeping up on tax obligations
If you bill your clients hourly, and you use the data about those billable hours to estimate your quarterly or annual tax burden, you’ll find that you’ll be ahead on tax prep when it comes time to send your money off into the ether of government spending.
Using Toggl to hone in on the billable rate that’s right for you and your financial goals means that you’ll be charging what you’re worth.
And taking advantage of Toggl’s reporting functions can help you estimate your tax burden ahead of time, so that when your accountant or accounting software comes back to you with a tax bill, you’re not scrambling to collect the cash.
Taxes aren’t particularly fun and they aren’t particularly straightforward, but Toggl can help take some of the guessing out of how you charge for your work and how you prepare to pay taxes on what you take in.