Tax-Equivalent Yield Calculator

Which Country's Taxes This Calculator Uses

This calculator describes United States income tax and nothing else. Municipal bonds are issued by American states, cities, counties and local authorities, and the interest they pay is normally exempt from the federal income tax the IRS collects, which is where the whole comparison comes from. The page asks for a federal rate and a state rate because that is how income is taxed in the United States: one tax charged nationally, another charged by the state you live in, and a municipal bond that can escape one, both or neither.

If you are taxed in another country, the arithmetic here will not describe your situation. The federal rate, the state rate and the exemption are features of United States tax law, and this page does not know how your country taxes bond interest, so a figure produced here would be a number without a meaning for you. Take the idea, which travels everywhere, and leave the rates, which do not.

What Is Tax-Equivalent Yield?

Tax-equivalent yield answers a practical question that every income investor faces: is a tax-free bond actually better than a taxable one? Because the interest on a municipal bond is generally exempt from federal income tax, and sometimes from state and local tax as well, you keep the entire yield rather than handing a slice to the tax authorities. A taxable bond, by contrast, hands you a higher headline yield but takes a portion of it back at tax time.

To compare the two fairly, you convert the tax-free yield into the pre-tax yield a taxable bond would need to match it after tax. That grossed-up number is the tax-equivalent yield. Comparing it directly against the yield on a taxable bond of similar credit quality and maturity tells you which investment leaves more money in your pocket.

The Tax-Equivalent Yield Formula

The simplest case is a bond that no income tax touches at all: divide its yield by one minus the share of a taxable bond's interest that tax takes. When your own state does tax the bond's interest, the calculator first takes that state tax off the tax-free yield and then divides. That is why the state rate you type is always used, and why switching on the state exemption raises the answer.

As a worked example, take a tax-free bond yielding 3.50% and an investor who pays 32% federal tax and no state tax: 3.50% ÷ (1 − 0.32) = roughly 5.15%. A taxable bond would need to yield more than 5.15% to leave that investor more after tax. The higher the tax rate, the larger this gap becomes.

Putting a State Rate Next to a Federal Rate

Combining the two rates is less obvious than it looks, so the calculator lets you choose the treatment rather than picking one quietly. With the deduction switch off, the two rates are simply added: a 32% federal rate and a 5% state rate become 37%. With it on, each point of state tax is counted as costing less, because the state tax paid reduces the income the federal government can tax, and the same pair becomes 35.40% instead. On a 3.50% tax-free yield from a bond your own state does not tax, that is the difference between needing 5.56% and needing 5.42% from a taxable bond. Which treatment describes you depends on whether you itemise your deductions and on the limit that applies to the deduction, so it is a question for whoever prepares your return rather than something this page can decide for you.

The Net Investment Income Tax

Investors above an income threshold set in United States law pay an extra 3.8% federal tax on investment income, the net investment income tax. It falls on taxable bond interest and not on tax-exempt municipal interest, which makes it part of this comparison rather than a footnote to it. Switching it on adds those 3.8 points to the tax taken from taxable interest: on a 3.50% tax-free yield at a 32% federal rate and no state tax, the taxable yield needed to match moves from 5.15% to 5.45%. The calculator has no way of knowing whether the tax reaches you, which is why it asks instead of assuming.

When Tax-Free Beats Taxable

Tax-free municipal bonds tend to win for investors in higher marginal tax brackets, because the value of the tax exemption scales with your tax rate. The same 3.50% tax-free yield that needs 5.15% from a taxable bond at a 32% rate needs 5.56% at a 37% rate. At a low tax rate the exemption is worth less, so a taxable bond needs a smaller yield advantage to come out ahead.

Credit quality and maturity matter just as much as the tax math. A municipal bond and a taxable bond should be compared only when they carry similar default risk and a similar time to maturity; otherwise you may be paying for a higher yield with hidden risk. It is also worth remembering that holding tax-exempt bonds inside a tax-advantaged account such as an IRA usually wastes the exemption, since those accounts already shelter the income.

One important caveat is the alternative minimum tax. Certain municipal bonds, known as private activity bonds, pay interest that can be subject to the AMT. If you are an AMT payer, the interest on those specific bonds may not be fully tax-free for you, which lowers their real tax-equivalent yield. Because AMT exposure depends on your complete tax picture, treat it as a flag to investigate rather than a number to assume.

To build a complete income picture, pair this tool with the dividend calculator to project income from dividend-paying stocks, and the present value calculator to discount a bond's future coupon stream back to today. Together they let you compare income across taxable and tax-free sources on a consistent basis.

Frequently Asked Questions About the Tax-Equivalent Yield Calculator