Calculate the taxable equivalent yield of municipal bonds based on your tax bracket to compare tax-free versus taxable investments.
Municipal bond interest is exempt from federal income tax, so a tax-free yield is worth more than the same number printed on a taxable CD or corporate bond. This tool converts a tax-free yield into its taxable equivalent by dividing by (1 minus your marginal tax rate), which lets you compare tax-free and taxable investments on an after-tax basis. The number most people get wrong is the rate: the formula needs the marginal rate on your last dollar of income, not your average rate, or the comparison understates the tax-free bond's advantage.
A concrete input and expected output from the current implementation.
Input
Municipal bond yield: 4.00%; marginal federal tax rate: 24%
Expected output
Taxable-equivalent yield: 5.26%. A taxable investment would need to beat 5.26% to come out ahead of the municipal bond; at exactly 5.26% the two tie, both worth 4.00% after tax.
Dividing the tax-free yield by (1 - 0.24) = 0.76 gives 4.00% / 0.76 = 5.26%. Checking the other direction, 5.26% x 0.76 = 4.00%, so after 24% federal tax a 5.26% taxable yield leaves exactly the muni's 4.00%.
The tool applies the standard formula: tax-free yield divided by (1 minus your marginal tax rate). Interest on most municipal bonds is exempt from federal income tax, so a 4% muni yield is worth 4% / (1 - 0.24) = 5.26% to someone in the 24% bracket. When the bond is also exempt from your state tax, the denominator uses the combined marginal rate: 1 - (federal + state - federal x state).
It also runs the comparison the other way: the after-tax yield of a taxable bond is its stated yield multiplied by (1 minus your rate). A taxable bond at exactly 5.26% yields 4.00% after 24% tax, the breakeven point; anything above beats the muni, anything below loses. If you enter taxable income and filing status, the tool determines the bracket before applying the formula.
Marginal. The exemption applies to the next dollar of interest, which is taxed at your top bracket rate. Your effective rate is total tax divided by total income and is always lower, so using it understates the equivalent yield and makes tax-free bonds look less attractive than they are. If the tool accepts income and filing status, it looks up the bracket itself; confirm the tax year of the table it uses.
Not directly. Treasury interest is exempt from state and local tax but is fully taxable federally, so the tax-equivalent formula, which assumes federal exemption, does not apply as written. To compare, take the Treasury's after-tax yield (stated yield times 1 minus your federal rate) and weigh it against the muni's taxable-equivalent yield, remembering that an in-state muni also escapes your state tax.
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