What is the 'TaxEquivalent Yield'
The taxequivalent yield is the pretax yield that a taxable bond needs to possess for its yield to be equal to that of a taxfree municipal bond. This calculation can be used to fairly compare the yield of a taxfree bond to that of a taxable bond to see which bond has a higher applicable yield. It is also known as aftertax yield.
BREAKING DOWN 'TaxEquivalent Yield'
The taxequivalent yield takes into account an individual investor's current tax rate to determine whether an investment in a municipal bond is equivalent to a corresponding investment in a given taxable bond. In some cases, when an investor is certain that he will be moving up or down to a tax different bracket, this calculation can also be used to make efficient investment decisions.TaxEquivalent Yield Formula
The formula for a bond's taxequivalent yield includes three variables:
R(te) = the taxequivalent yield for a given investor
R(tf) = the taxfree investment's yield
t = the investor's current marginal tax rate
Given these variables, the formula for an investment's taxequivalent yield is:
R(te) = R(tf) / (1  t)
Even though taxfree investments such as municipal bonds generally have a low expected return, the full impact of investing in them due to tax savings is often not quantified completely.
Example Calculations
An investor's tax rate has a significant difference in the resulting taxequivalent yields. For example, assume there is a taxfree bond that is yielding 7%. A decision to invest in this particular bond or any of the many taxable choice available greatly depends on the investor's marginal tax bracket. In the United States, as of 2016, there are seven different marginal taxrate brackets: 10%, 15%, 25%, 28%, 33%, 35% and 39.6%. The taxequivalent yield calculations for these brackets are as follows:
10% Bracket: R(te) = 7% / (1  10%) = 7.78%
15% Bracket: R(te) = 7% / (1  15%) = 8.24%
25% Bracket: R(te) = 7% / (1  25%) = 9.33%
28% Bracket: R(te) = 7% / (1  28%) = 9.72%
33% Bracket: R(te) = 7% / (1  33%) = 10.45%
35% Bracket: R(te) = 7% / (1  35%) = 10.77%
39.6% Bracket: R(te) = 7% / (1  39.6%) = 11.59%
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% nontaxable bond. Investors in the highest three brackets would be better off investing in the taxfree bond.

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