what is tax equivalent yield 
the tax equivalent yield is the return that a taxable bond needs to possess for its yield to equal the yield on a comparable tax exempt municipal bond this calculation is a tool investors can use to compare the returns between a tax free investment and a taxable alternative tax implications are a complicated and important part of any financial strategy and are often overlooked the tax equivalent yield calculation is a useful tool for investors especially those in higher tax brackets investopedia jiaqi zhouunderstanding tax equivalent yieldthe tax equivalent yield is the yield on a taxable bond that an investor would have to earn to match the return on a comparable tax free municipal bond in general municipal bonds have a low expected return so the full impact of investing in them is often not quantified completely while the tax free advantage municipal bonds offer can be hard to match with other investments it is not the end of the story additional tax considerations are relevant for example while municipal bonds are free of federal taxes some states tax the earnings the liquidity of municipal bonds may also be limited tax equivalent yield formuladepending on an investor s tax bracket a municipal bond may not be the best investment decision for their portfolio an investor s tax bracket will depend on their filing status and income the federal income tax brackets for 2023 and 2024 are 10 12 22 24 32 35 and 37 1to calculate the taxable equivalent yield of a tax free municipal bond use the following formula be sure to include any state taxes along with your federal tax rate return tey return tx 1 t where return tey return on fully taxable equivalent yield return tx return on tax exempt investment t investor s marginal tax rate begin aligned text return text tey text return text tx div 1 t textbf where text return text tey text return on fully taxable equivalent yield text return text tx text return on tax exempt investment t text investor s marginal tax rate end aligned returntey returntx 1 t where returntey return on fully taxable equivalent yieldreturntx return on tax exempt investmentt investor s marginal tax rate this formula can be reversed to determine the tax free equivalent yield of a municipal bond that would match the return on a taxable bond tax equivalent yield calculationsan investor s tax rate plays a significant role in the resulting tax equivalent yields for example assume there is a tax free bond that is yielding 7 a decision to invest in this particular bond or any of the many taxable choices available greatly depends on the investor s marginal tax bracket in 2023 there are seven different marginal tax rate brackets in the u s 10 12 22 24 32 and 35 the tax equivalent yield calculations for these brackets are as follows given this information assume there is a taxable bond that is yielding 9 75 in this situation investors in the first four marginal tax brackets would be better off investing in the taxable bond because even after paying their tax liability they would still earn more than a 7 non taxable bond investors in the highest three brackets would be better off investing in the tax free bond however none of this is investment advice a tax or financial advisor should be consulted example of tax equivalent yieldan investor in the 22 federal income tax bracket with no state taxes owns a tax exempt municipal bond with an 8 coupon rate to calculate the fully taxable equivalent yield that a taxable bond would have to earn to match the municipal bond s yield use the above formula return tey 0 08 1 0 22 10 26 begin aligned text return text tey 0 08 div 1 0 22 10 26 end aligned returntey 0 08 1 0 22 10 26 in other words a taxable bond would have to earn an equivalent yield of 10 26 after taxes are deducted this bond would match the 8 return of the tax free municipal bond if the marginal tax rate is higher the required fully taxable equivalent yield will also be higher than 10 26 so if all else remains the same the only difference being that the investor is in the 37 tax bracket the fully taxable equivalent yield would have to be return tey 0 08 1 0 37 12 70 begin aligned text return text tey 0 08 div 1 0 37 12 70 end aligned returntey 0 08 1 0 37 12 70 