How to calculate taxable-equivalent yield
The basic formula is TEY = Tax-Free Yield ÷ (1 − Your Combined Tax Rate). Your combined tax rate may include federal, state, local, and other applicable taxes.
For example, a 3.75% in-state municipal bond for an investor in a 50.3% combined tax bracket has a taxable-equivalent yield of approximately 7.55%. In other words, a fully taxable investment would need to yield about 7.55% to produce the same after-tax income.
Real-world comparisons, however, are more complicated. Treasuries are exempt from state income tax, out-of-state municipal bonds may still be taxable at the state level, and the 3.8% Net Investment Income Tax (NIIT) can affect taxable investments. Bond TEY automatically accounts for these differences so investors can compare municipal bonds, Treasuries, and taxable investments on the same after-tax basis.
How municipal, Treasury, and taxable bonds are taxed
In-State Municipal Bond
Interest is generally exempt from both federal and home-state income taxes, making it especially attractive for investors in high-tax states.
Out-of-State Municipal Bond
Interest is generally exempt from federal income tax but still subject to your state's income tax.
U.S. Treasury
Interest is exempt from state and local income taxes but fully taxable at the federal level.
Taxable Bond
Corporate bonds, CDs, and other investments whose interest is generally taxable at both the federal and state level.
Frequently asked questions about tax-equivalent yield
What is taxable-equivalent yield (TEY)?
Taxable-equivalent yield is the pre-tax yield a taxable investment would need to match the after-tax income from a tax-advantaged investment such as a municipal bond. It is also called tax-equivalent yield, and both abbreviate to TEY.
What is the tax-equivalent yield formula?
The basic formula is TEY = tax-free yield ÷ (1 − your marginal tax rate). For example, a 3% muni at a 37% federal rate has a tax-equivalent yield of about 4.76% (3% ÷ 0.63). State tax and the 3.8% NIIT change the math by bond type, which this calculator handles automatically.
Is taxable-equivalent yield the same as tax-equivalent yield?
Yes. The two phrases describe the same concept — the pre-tax yield a taxable bond needs to match a tax-free bond's after-tax income — and both are abbreviated TEY.
Why do in-state municipal bonds often look more attractive?
Their interest is generally exempt from both federal and home-state income tax, so a lower stated yield can still deliver more after-tax income — particularly for investors in high-tax states. The calculator quantifies that by converting each bond to an equivalent yield.
Are U.S. Treasuries exempt from state tax?
Yes — Treasury interest is exempt from state and local income tax, though it is fully taxable at the federal level and subject to the 3.8% surtax (if applicable). That state exemption is why a Treasury can outperform a higher-coupon corporate bond for a resident in a high-tax state.
Does the 3.8% NIIT apply to municipal bond interest?
No. Tax-exempt municipal interest is not included in net investment income, so the surtax does not apply. It can apply to taxable bonds and Treasuries (if income thresholds are met), which is why enabling it changes those comparisons.
What does the Effective rate option do?
Instead of selecting a statutory bracket, it lets you enter a blended federal rate — useful when deductions or income spanning two brackets result in an effective rate that differs from the standard tiers.