What is tax equivalent yield?

Tax equivalent yield is the pre-tax yield a taxable bond would need to produce the same after-tax income as a tax-exempt municipal bond in your tax bracket. It is calculated as the tax-free yield divided by one minus your combined marginal tax rate.

Does tax equivalent yield use marginal or effective tax rate?

Marginal rate. Municipal interest sits on top of your other income, so the bracket applied to your last dollar is the one that matters. Using your overall effective rate understates the tax advantage of a muni bond.

Should state and local taxes be included?

Include them only if the bond is issued in your state of residence. In-state municipal bonds are typically exempt from state and local income tax as well as federal tax, while out-of-state issues usually escape federal tax but remain taxable at the state level.

Does itemizing deductions change the calculation?

Yes. If you deduct state and local taxes, the state tax you pay reduces federal taxable income, so your combined marginal rate is lower than the simple sum of federal plus state. The calculator offers both methods. The SALT deduction cap of $10,000 limits this for many filers.

Does tax equivalent yield account for AMT or NIIT?

Not by default. Interest on private activity municipal bonds can be subject to the Alternative Minimum Tax, and the 3.8% net investment income tax applies to taxable interest but generally not to municipal interest. Both widen the muni advantage beyond what the basic formula shows.

Tax Equivalent Yield Calculator — Muni vs Taxable Bond Comparison

What the number actually says

The tax equivalent yield is the answer to one question: what would a fully taxable bond have to pay me to end up with the same money in my pocket? It is not a forecast of returns. It is a conversion that makes two differently-taxed yields comparable.

Municipal bond interest is generally exempt from federal income tax. Corporate bond interest is not. So a 3.5% muni and a 4.0% corporate bond are not 0.5 percentage points apart — the gap depends entirely on the bracket you are in.

The formula

Tax equivalent yield = Tax-free yield ÷ (1 − combined marginal tax rate)

And the reverse, when you start from a taxable yield:

Equivalent tax-free yield = Taxable yield × (1 − combined marginal tax rate)

The combined marginal rate is where most online calculators quietly go wrong. There are two defensible ways to build it, and they give different answers.

Method 1 — simple addition (standard deduction)

Combined rate = federal + state + local

Use this if you take the standard deduction. Your state tax bill does not reduce your federal taxable income, so the rates stack without adjustment.

Method 2 — itemized (state tax is federally deductible)

Combined rate = state + local + federal × (1 − state − local)

If you itemize, every dollar of state tax you pay also removes a fraction of a dollar from federal taxable income. On an extra dollar of income you pay state and local first, then federal on what is left. Ignoring this overstates your combined rate and makes the muni look better than it is.

The SALT cap matters here. Federal law limits the state and local tax deduction — $10,000 per return under current rules. For high earners with large state tax bills, the deduction is already maxed out, so the simple addition method is the more accurate of the two. If your state and local taxes are well under the cap, Method 2 is closer to reality.

Worked example

You are in the 32% federal bracket, live in a state with a 5% income tax, and the bond is issued in your state. You take the standard deduction.

Combined marginal rate = 32% + 5% = 37%
Tax-free yield = 3.5%
Tax equivalent yield = 3.5% ÷ (1 − 0.37) = 5.56%

So a taxable bond must pay more than 5.56% to leave you better off than the 3.5% muni. A 5.2% corporate bond looks higher on the screen and is actually worse after tax.

Tax equivalent yield across federal brackets

Same 3.5% tax-free yield, no state or local tax, standard deduction. The right-hand bar shows how much the muni advantage grows as your bracket rises.

Federal bracket	Combined rate	Taxable equivalent	Advantage over the 3.5% muni

A 3.5% tax-free yield is worth 3.89% to someone in the 10% bracket and 5.56% to someone in the 37% bracket. The bond did not change. The investor did. This is why municipal bonds are structurally a product for high earners.

Three things this calculator does not do

It does not account for AMT. Interest on private activity municipal bonds — airport bonds, some housing and industrial development issues — can be subject to the Alternative Minimum Tax. If you are near the AMT threshold, check the issue's AMT status before assuming the interest is fully exempt.

It does not add the net investment income tax. The 3.8% NIIT applies to taxable interest above the income thresholds, but municipal interest is generally excluded. That makes the muni advantage slightly larger than the basic formula shows for high earners.

It ignores credit risk and duration. A 5.5% taxable yield on a BBB corporate bond and a 5.5% taxable-equivalent muni are not equivalent investments. Default risk, call features, liquidity and maturity all differ. Tax equivalence is one dimension, not a recommendation.

When the comparison is not worth doing

If you are in the 10% or 12% bracket, the arithmetic rarely justifies the complexity. A 3.5% muni converts to only 3.89–3.98% taxable, and taxable yields of that level are easy to find in Treasuries and CDs without giving up liquidity or taking municipal credit risk.

The calculation starts to matter around the 24% bracket and becomes decisive at 32% and above. That is also where the supply of in-state, high-grade municipal paper tends to be thinnest relative to demand.

Questions

Should I use my marginal rate or my effective rate?: Marginal. The muni's interest lands on top of your other income, so the rate applied to your last dollar is the relevant one. Effective rate — total tax divided by total income — will understate the benefit and make you reject bonds you should be looking at.
What if the bond is issued in another state?: You usually keep the federal exemption but lose the state one. Set the state tax field to 0 and add only federal. For a resident of a high-tax state this can swing the answer by a full percentage point.
Do Treasury bonds belong in this comparison?: Treasuries are exempt from state and local tax but taxable at the federal level. The comparison works, but you need to model it as federal-only taxation rather than running it through the muni formula. It is a different problem from the one this page solves.
Is a higher tax equivalent yield automatically the better investment?: No. It tells you the two bonds are equivalent after tax — nothing more. Once they are equivalent on tax, you choose on credit quality, duration, call protection and liquidity. A tax-equivalent tie between a AA muni and a BBB corporate is not a tie.