Comparing Taxable and Tax Exempt Bond Yields
The Internal Revenue Code allows individuals to treat interest income from most municipal obligations as tax exempt. This beneficial tax provision enables municipal entities to raise capital more cheaply to fund their development and operations.
For individuals, the benefit of tax exempt interest income can be attractive if they are in a high income tax bracket. To determine if the tax exempt route is right for you, it is necessary for you to compare the after-tax yield of a taxable bond to the yield of a tax-exempt bond. It's important to compare bonds of similar maturity dates and similar quality.
To calculate the after-tax yield of a taxable bond you can use the following formula:
For example, here is the equation to calculate the after tax yield of a taxable bond with a yield of 6% for someone in the 35% marginal tax bracket.
AFTER TAX YIELD = 6% - (6% X .35)
= 6% - (2.1%)
= 3.9%
Or you can use the following table:
| Tax-exempt yield | Equivalent taxable yields in these marginal tax brackets |
| 15% | 25% | 28% | 33% | 35% |
3.0% | 3.5 | 4.0 | 4.2 | 4.5 | 4.6 |
3.5% | 4.1 | 4.7 | 4.9 | 5.3 | 5.4 |
4.0% | 4.7 | 5.3 | 5.6 | 6.0 | 6.2 |
4.5% | 5.3 | 6.0 | 6.3 | 6.8 | 6.9 |
5.0% | 5.9 | 6.7 | 6.9 | 7.5 | 7.7 |
5.5% | 6.5 | 7.3 | 7.6 | 8.3 | 8.5 |
The tax brackets are those in effect in 2009.
Remember, to get a true comparison, it is critical that the taxable and tax exempt bonds have similar maturity dates and similar quality ratings.
| Note: This educational information is not meant as financial advice. Be sure to consult your APEXX financial advisor to determine how the information applies to your situation. |
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