Tax-Equivalent Yield Calculator
Convert a tax-free municipal bond yield into the taxable yield needed to match it after federal, state, and local taxes
About the Tax-Equivalent Yield Calculator
The Tax-Equivalent Yield Calculator is a vital tool for fixed-income investors who need to compare the performance of tax-exempt municipal bonds against taxable investments like corporate bonds, certificates of deposit (CDs), or Treasury notes. Because municipal bonds are often exempt from federal—and sometimes state or local—income taxes, their stated interest rates appear lower than those of taxable counterparts. However, for investors in high tax brackets, the actual take-home pay from a 'lower' municipal yield can often exceed the after-tax return of a 'higher' taxable yield.
This calculator allows investors to bridge the gap between these two different financial instruments. By inputting the municipal bond's coupon rate and the investor's combined marginal tax rate, the tool reveals the 'break-even' point. Financial advisors and individual retirees frequently use this calculation to optimize asset allocation within taxable brokerage accounts, ensuring they are not overpaying the government at the expense of their portfolio's growth. Understanding this relationship is essential for any investor whose annual income places them in the mid-to-upper federal tax tiers.
Formula
TEY = Tax-Exempt Yield / (1 - Marginal Tax Rate)The Tax-Equivalent Yield (TEY) is calculated by dividing the tax-free interest rate of a municipal bond by the quantity of one minus your total marginal tax rate. The marginal tax rate should be expressed as a decimal (e.g., 24% becomes 0.24). This total rate should include your federal income tax bracket and, if applicable, state and local income tax rates. This formula determines the gross yield a taxable security must offer to match the net after-tax return of the municipal bond.
Worked examples
Example 1: A Florida resident in the 24% federal tax bracket (no state tax) is looking at a municipal bond paying 3.5%.
Tax-Exempt Yield = 0.035\nTax Rate = 0.24\nCalculation: 0.035 / (1 - 0.24)\n0.035 / 0.76 = 0.04615...
Result: 4.62% taxable yield. The investor would need a corporate bond paying at least 4.62% to beat the 3.5% tax-free bond.
Example 2: A high-earner in a state with no income tax is in the 35% federal bracket and considers a 5% municipal bond.
Tax-Exempt Yield = 0.05\nTax Rate = 0.35\nCalculation: 0.05 / (1 - 0.35)\n0.05 / 0.65 = 0.07692...
Result: 7.69% taxable yield. Due to the high tax bracket, the 5% municipal bond is highly competitive against taxable options.
Example 3: An investor in a 32% federal bracket and a 5% state bracket (37% total) considers a 4.3% in-state municipal bond.
Tax-Exempt Yield = 0.043\nCombined Tax Rate = 0.32 + 0.05 = 0.37\nCalculation: 0.043 / (1 - 0.37)\n0.043 / 0.63 = 0.06825...
Result: 6.85% taxable yield. This accounts for the combined burden of federal and state taxes.
Common use cases
- An investor in the 35% federal tax bracket deciding between a 3% muni bond and a 4% corporate bond.
- A California resident comparing an in-state municipal bond against a high-yield savings account.
- A financial planner determining if a client should move assets from a taxable brokerage account into tax-exempt securities.
Pitfalls and limitations
- The formula assumes the investor is not subject to the Alternative Minimum Tax which can impact certain municipal bonds.
- It does not account for the 3.8% Net Investment Income Tax (NIIT) which may apply to taxable interest but not municipal interest.
- State tax exemptions usually only apply if the investor lives in the state where the bond was issued.
- The calculation assumes the bond is purchased at par; if bought at a discount, the 'de minimis' rule may trigger taxable gains.
Frequently asked questions
does tax equivalent yield go up with higher income
Tax-equivalent yield is higher for individuals in top tax brackets because they save more on taxes by holding municipal bonds. If you are in the 10% bracket, the tax advantage is minimal, but in the 37% bracket, a 4% municipal yield is equivalent to over 6% in a taxable bond.
are municipal bonds always 100 percent tax free
While municipal bonds are generally exempt from federal income tax, they can be subject to the Alternative Minimum Tax (AMT) if they are private activity bonds. Additionally, if you sell a municipal bond for more than you paid, you may owe capital gains tax even if the interest income was tax-free.
how to calculate tax equivalent yield with state tax
To account for state taxes, you must use the combined marginal rate of your federal and state tax brackets. However, this only applies if the municipal bond was issued in your home state; bonds from other states are usually taxable at the state level.
difference between taxable yield and tax equivalent yield
A taxable yield is the raw interest rate on an investment like a corporate bond or CD before taxes are taken out. The tax-equivalent yield is a calculated figure that allows you to compare that taxable rate directly to a tax-exempt municipal bond to see which puts more money in your pocket.
is capital gains included in tax equivalent yield
Capital gains from the sale of a municipal bond are not tax-exempt. The tax-equivalent yield formula only applies to the interest income (coupon payments) generated by the bond, not the profit made from price appreciation.