Tax Equivalent Yield Calculator
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The Tax Equivalent Yield (TEY) is the pretax interest rate that a taxable bond (such as a corporate bond or CD) must pay for its net yield to equal the tax-free return of a municipal bond. Because interest income from municipal bonds is generally exempt from federal income taxes (and often state/local taxes), investors in high marginal tax brackets often enjoy significantly higher after-tax returns from municipal securities.
Our free Tax Equivalent Yield Calculator computes your equivalent taxable return based on your tax bracket and municipal coupon yield.
How to Calculate Tax Equivalent Yield (TEY)
TEY adjusts the tax-exempt municipal coupon rate by your marginal income tax bracket.
The Tax Equivalent Yield Formula:
Tax Equivalent Yield = Tax-Free Municipal Yield / ( 1 - Marginal Tax Rate )
Combined Federal & State Tax Formula:
If the municipal bond is exempt from both federal and state income tax (double tax-free), use the effective combined tax rate:
Effective Combined Tax Rate = Federal Rate + State Rate × ( 1 - Federal Rate )
Tax Equivalent Yield Comparison by Tax Bracket
The higher your marginal tax bracket, the greater the yield advantage of holding tax-exempt municipal bonds:
| Tax-Free Municipal Yield | 22% Tax Bracket | 32% Tax Bracket | 37% Tax Bracket |
|---|---|---|---|
| 3.00% | 3.85% | 4.41% | 4.76% |
| 4.00% | 5.13% | 5.88% | 6.35% |
| 5.00% | 6.41% | 7.35% | 7.94% |
Step-by-Step Calculation Example
An investor in the 35% federal marginal tax bracket is comparing two fixed-income opportunities:
- Municipal Bond Yield (Tax-Exempt): 4.25%
- Corporate Bond Yield (Taxable): 6.00%
Step 1: Compute Tax Equivalent Yield
TEY = 4.25% / ( 1 - 0.35 ) = 4.25% / 0.65 = 6.54%
Step 2: Compare Returns
The municipal bond’s Tax Equivalent Yield of 6.54% exceeds the corporate bond yield of 6.00%. Therefore, despite a lower nominal coupon rate, the municipal bond delivers a higher net yield after accounting for taxes.
Frequently Asked Questions (FAQ)
Are municipal bonds always completely tax-free?
Municipal bond interest is exempt from federal income tax. Additionally, if you purchase bonds issued by your home state or local city, interest is usually exempt from state and local taxes. However, capital gains realized when selling municipal bonds are taxable.
Does the Alternative Minimum Tax (AMT) apply to municipal bonds?
Certain private activity municipal bonds (e.g., industrial development or airport financing bonds) may be subject to the federal Alternative Minimum Tax (AMT). Investors subject to AMT should verify the tax status of individual bond issues.
Who gains the most benefit from Tax Equivalent Yield calculations?
Investors in higher marginal income tax brackets (e.g., 32%, 35%, or 37%) benefit the most from municipal bonds because their high tax rate significantly inflates the equivalent taxable yield required on corporate bonds.