Comparing tax-free and taxable yields
Municipal bonds usually pay lower yields than Treasuries, corporate bonds or CDs, because their interest is free of federal income tax. To compare them fairly, convert the tax-free yield into the tax-equivalent yield: the taxable yield that would leave you with the same income after tax.
The formula
Tax-equivalent yield = tax-free yield ÷ (1 − tax rate)
The calculator builds the tax rate from:
- your federal bracket (10% to 37%);
- your state income tax, added only if the bond is issued in your state, since out-of-state munis are generally taxed by your state;
- the 3.8% net investment income tax, if your income is above $200,000 single or $250,000 married filing jointly.
Adding the rates is a simplification: if you itemize, state tax is deductible federally within the SALT cap, which lowers the combined rate slightly.
Worked example
A 3.5% in-state municipal bond for an investor in the 24% federal bracket with a 5% state tax:
- Combined rate: 24% + 5% = 29%.
- Tax-equivalent yield: 3.5% ÷ (1 − 0.29) ≈ 4.93%.
- A taxable CD paying 5% keeps 5% × 0.71 = 3.55% after tax.
- The CD comes out slightly ahead, by 0.05 point.
How the bracket changes the answer
| Federal bracket | Tax-equivalent of a 3.5% muni (no state tax) |
|---|---|
| 12% | 3.98% |
| 22% | 4.49% |
| 24% | 4.61% |
| 32% | 5.15% |
| 37% | 5.56% |
The higher your bracket, the more a tax-free yield is worth. In low brackets, taxable bonds often pay more after tax.
Other points to check
- Credit quality: compare bonds of similar rating. A municipal bond and a corporate bond with the same yield do not carry the same risk.
- Alternative minimum tax: interest on some private activity bonds is subject to AMT.
- Treasuries: their interest is exempt from state tax but not from federal tax, which matters in high-tax states.
- Tax-advantaged accounts: inside an IRA or 401(k), the muni tax advantage is wasted, so taxable bonds usually belong there.
- Duration: longer bonds carry more interest rate risk; compare similar maturities.
This calculator gives estimates for education and planning. It is not investment, tax or legal advice; for decisions about your own situation, talk to a qualified financial professional.