Tax-Equivalent Yield

Tax-Equivalent Yield

To be able to compare taxable bonds with tax-exempt bonds, investors need to adjust the yields to neutralise the tax effects. This is particularly the case for those in high-income groups since they sit in high tax brackets. For a single US taxpayer earning above US$539,901 (so in the 2021 37% Federal tax bracket), a taxable bond would have to offer a yield of 6.35% for its return to be comparable to that of a tax-exempt bond yielding 4% - the tax-exempt yield divided by [1 less the tax rate]. Some muni bonds are also exempt from state taxes so if our investor resides in California and is also liable for state income tax of 11.3%, the taxable bond would need to offer a 7.74% yield to compare with the muni bond offering 4%.

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