Tax-Equivalent Yield Calculator

What Are Municipal Bonds? Municipal bonds (munis) are debt securities issued by states, cities, counties, and other government entities to fund public projects — roads, schools, hospitals, and utilities. The key advantage: interest income from most municipal bonds is exempt from federal income tax. Many munis are also exempt from state and local taxes if you live in the state of issuance. This tax exemption makes them attractive to investors in high tax brackets, even though their stated yields are lower than taxable bonds.

The Tax-Equivalent Yield Concept A muni yielding 3% is not directly comparable to a taxable bond yielding 4.5%. To compare fairly, you need to ask: “What taxable yield would I need to match the muni yield after taxes?” That is the tax-equivalent yield (TEY). TEY = Municipal Yield / (1 − Tax Rate)

Example: Muni yields 3%, investor is in the 32% federal bracket. TEY = 3% / (1 − 0.32) = 3% / 0.68 = 4.41% This means a taxable bond must yield MORE than 4.41% to beat the muni after taxes. If the taxable bond yields only 4.2%, the muni bond wins despite its lower stated rate.

Combined Federal + State Tax Rate If your state also taxes bond income (but not the muni), the combined tax rate is: Combined Rate = Federal Rate + State Rate − (Federal Rate × State Rate) The subtraction avoids double-counting — state taxes are deductible on federal returns when itemizing. This formula gives the accurate marginal rate on fully taxable bond income.

Example: 32% federal + 6% state: Combined = 0.32 + 0.06 − (0.32 × 0.06) = 0.38 − 0.0192 = 0.3608 = 36.08%

The Break-Even Tax Rate The break-even tax rate is the marginal tax rate at which a muni and a taxable bond deliver identical after-tax returns. Break-even rate = 1 − (Muni Yield / Taxable Yield) If your actual combined rate exceeds the break-even rate, the muni bond is better. If your rate is below the break-even, the taxable bond wins.

After-Tax Yield of a Taxable Bond After-Tax Yield = Taxable Yield × (1 − Combined Tax Rate) This is the actual percentage of your investment you keep after taxes on a taxable bond. Compare this directly against the muni yield — no adjustments needed since munis are already after-tax.

Who Benefits Most From Municipal Bonds? Investors in the 32%, 35%, and 37% federal brackets see the greatest benefit. Investors in brackets below 22% usually do better with taxable bonds. The sweet spot depends on your state tax rate — high-tax states (CA, NY, NJ) amplify the benefit. Tax-deferred accounts (IRA, 401k) should NOT hold municipal bonds — you already avoid current taxes, and munis yield less to compensate for their tax advantage. Always consider the credit quality of the issuer — munis are generally safe but not risk-free.

AMT Consideration Some private activity bonds (a subset of munis) are subject to the Alternative Minimum Tax (AMT). If you are subject to AMT, check whether the specific bond is AMT-exempt before purchasing. Standard general obligation and revenue bonds issued by state and local governments are typically AMT-exempt.