What is Tax Equivalent Yield?
Tax equivalent yield (TEY) is the yield that a taxable bond must offer to match the after-tax return of a tax-exempt municipal bond. Because municipal bond interest is typically exempt from federal income tax — and often from state and local taxes as well — their stated yields appear lower than comparable taxable bonds. The tax equivalent yield calculation levels the playing field so investors can make an apples-to-apples comparison.
For example, if you are in the 24% federal tax bracket and a municipal bond yields 3.5%, the tax equivalent yield would be approximately 4.61%. This means you would need a taxable bond yielding at least 4.61% to match the after-tax income from the 3.5% municipal bond.
Tax Equivalent Yield Formula
The tax equivalent yield formula is straightforward. It divides the tax-exempt yield by the complement of your marginal tax rate:
TEY = Tax-Exempt Yield / (1 - Marginal Tax Rate)
When accounting for both federal and state taxes, the combined marginal tax rate is used:
TEY = Tax-Exempt Yield / (1 - (Federal Rate + State Rate))
Where:
- Tax-Exempt Yield = the stated annual yield of the municipal bond
- Federal Rate = your marginal federal income tax rate (e.g., 22%, 24%, 32%)
- State Rate = your state income tax rate (0% in states with no income tax)
Why Municipal Bonds Are Tax-Exempt
Municipal bonds are issued by state and local governments to fund public projects such as schools, highways, hospitals, and infrastructure. To encourage investment in these public-purpose bonds, the federal government exempts the interest income from federal income tax. In many cases, if you purchase a municipal bond issued within your state of residence, the interest is also exempt from state and local taxes — making it "triple tax-free."
When to Use Tax Equivalent Yield
The tax equivalent yield calculation is most valuable in these scenarios:
- Comparing muni bonds to corporate bonds: When deciding between a tax-exempt municipal bond and a taxable corporate or Treasury bond, TEY tells you the true after-tax comparison.
- Higher tax brackets: The higher your marginal tax rate, the more valuable the tax exemption becomes. Investors in the 32% or 37% bracket benefit most from municipal bonds.
- High-tax states: Residents of states like California, New York, New Jersey, and Oregon with high state income taxes gain additional benefit from in-state municipal bonds.
- Retirement planning: Tax-exempt income does not count toward provisional income thresholds that can trigger taxation of Social Security benefits.
How to Use This Tax Equivalent Yield Calculator
- Enter the Tax-Exempt Yield: Input the annual yield of the municipal bond you are considering. This is the coupon rate or current yield shown on the bond.
- Choose Your Federal Tax Rate: Select "By Income" to automatically determine your marginal federal tax bracket based on your filing status and taxable income, or choose "Custom Rate" to enter your rate directly.
- Enter Your State Tax Rate: Input your state income tax rate. Enter 0% if your state has no income tax (e.g., Texas, Florida, Nevada, Wyoming, Washington, South Dakota, Alaska, New Hampshire, Tennessee).
- Click Calculate: View the tax equivalent yield, combined tax rate, and per-$1,000 income comparison.
Why Use Our Tax Equivalent Yield Calculator?
Built-In Tax Brackets
Automatically determines your federal marginal rate from 2024 tax brackets based on income and filing status.
Federal + State Taxes
Accounts for both federal and state income taxes to give you a complete picture of the tax advantage.
Bracket Reference Table
View TEY across all federal tax brackets at a glance with the built-in reference table.
Completely Free
No registration, no limits. Use our tax equivalent yield calculator as many times as you need.