The Taxable Equivalent Yield and Municipal Bonds
(includes calculator)

The Taxable Equivalent Yield is the return that an investor would require on a taxable investment in order to make it equal to the return on a tax-exempt investment. The taxable equivalent yield calculation is commonly applied when evaluating municipal bond investments as the primary appeal of municipal bonds is that the interest income is exempt from regular federal income taxation. Many are exempt from state taxation as well.

About Municipal Bonds

A municipal bond or “muni” is a debt security issued by a state, municipality or county to finance its capital expenditures. Municipal bonds usually provide the investor with lower returns than comparable corporate bonds, which are taxed. For income-oriented investors, it is very important to have more money after taxes have been deducted.

Today, the municipal bonds market is approximately $1.7 trillion with over 50,000 state and local entities issuing these securities.

Municipal Bonds and State Taxes

Most states offer an advantage to buying municipal bonds issued within the state. These states tax the income on out-of-state bonds, but bonds issued within the state are given tax-free status.

There are, however, several states that grant tax-free status to municipals from all states. For investors faced with city income tax, municipals can shield from federal, state and local income tax. This is called “triple tax-free” status.

Click here for tax information for each state

The Tax Equivalent Yield Calculation

The taxable equivalent yield calculation assists the investor in determining which investment (taxable or non-taxable) might make more sense for them as it makes the evaluations of the returns comparable by figuring in the tax consequences.

The formula for taxable equivalent yield is:

TEY = Return on Tax-Free Investment / (1- Investor’s Marginal Tax Rate)

Just One Piece of the Investment Decision

The TEY is, however, just one factor that should be considered when making the investment decision. It offers a general guideline when comparing investment returns.

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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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