Equivalent taxable yield

Equivalent taxable yield

The yield that must be offered on a taxable bond issue to give the same after-tax yield as a tax-exempt issue.

Taxable Equivalent Yield

The yield of a taxable investment that equals the yield of a tax-free investment with a lower stated yield. A corporate bond yields less than its stated interest rate because of taxation, whereas a tax-exempt municipal bond does not. Thus, a municipal bond paying a lower interest rate will often net the bondholder more than a corporate bond with a slightly higher interest rate, depending upon one's tax bracket. The taxable equivalent yield is the extra yield required on a corporate bond to equal the yield of a municipal bond. See also: Municipals-over-bonds spread, After-tax basis.

Tax-Equivalent Yield

The yield of a taxable investment that equals the yield of a tax-free investment with a lower stated yield. A corporate bond yields less than its stated interest rate because of taxation whereas a tax-exempt municipal bond does not. Thus, a municipal bond that pays a lower interest rate will often net the bondholder more than a corporate bond with a slightly higher interest rate, depending upon one's tax bracket. The tax equivalent yield is the extra yield required on a corporate bond to equal the post-tax yield of a municipal bond. See also: Municipals-over-bonds spread, After-tax basis.

equivalent taxable yield

The taxable return that must be achieved in order to equal, on an aftertax basis, a given tax-exempt return. Equivalent taxable yield is calculated by dividing the available tax-exempt yield by one minus the investor's marginal tax rate. For example, a tax-exempt return of 9% for an investor in a 40% marginal tax bracket would require a taxable return of .09/0.6 , or 15%, to produce the same aftertax equivalent.
Does the purchase of tax-free securities make sense?

Analyze investments for risk related to return (payout and growth) and yield. Tax-free securities have less risk, but their return is usually lower than riskier growth investments, corporate bonds, or preferred stocks. Determine the equivalent taxable yield of a tax-free security (yield divided by the difference of one minus your marginal tax bracket). Compare the investment to alternative securities with similar or higher yields or returns. Invest for a higher return if you are comfortable with the risk. Tax-free securities make sense for high-income taxpayers looking for safer, certain returns.

Jeffrey S. Levine, CPA, MST, Alkon & Levine, PC, Newton, MA

Equivalent taxable yield.

While taxable bonds normally pay higher interest rates than tax-exempt bonds, they sometimes provide a lower overall yield.

Finding the equivalent taxable yield lets you determine the minimum interest rate a taxable bond must pay to equal the yield of a comparable tax-exempt bond. The formula for the equivalent taxable yield is tax-exempt interest rate ÷ (100 - your tax rate).

So, for example, if a municipal bond pays an annual interest rate of 7%, and your tax rate is 35%, the equivalent taxable yield would be 7 ÷ (100 - 35) = 10.8%. That means that in order to be as attractive an investment as the 7% municipal bond, a taxable bond would need to pay an annual interest rate of 10.8% or more.

References in periodicals archive ?
Equivalent Taxable Yield = Tax-Free Yield / 100 - Tax Bracket
Because munis typically pay lower coupon rates, they are most attractive to high-income investors whose after-tax return will be higher despite lower rates of interest (see table of Equivalent Taxable Yields on page 122).
To determine whether a particular investor would benefit from investing in municipal bonds, CPAs must convert the tax-free return to an equivalent taxable yield, as described in the sidebar on page 52.
To compare municipal and taxable bonds, the yield on a municipal bond can be converted to an equivalent taxable yield. This is done by dividing the tax-exempt yield by the difference between 1.00 and the investor's marginal tax rate (1.00-MTR).
Municipal bonds provide a greater return for those in higher tax brackets: A 6 percent tax-exempt rate for a 30-year bond for an investor in the 39.6 percent bracket would require an equivalent taxable yield of 9.9 percent.
Source: www.treasurydirect.gov/indiv/research/indepth/ebonds/ res_e_bonds_eecomparison.htm Equivalent Taxable Yields 2010 Federal Income Tax Brackets Tax Exempt Yield 15% 25% 28% 33% 35% 2.00 2.35 2.67 2.78 2.99 3.08 2.25 2.65 3.00 3.13 3.36 3.46 2.50 2.94 3.33 3.47 3.73 3.85 2.75 3.24 3.67 3.82 4.10 4.23 3.00 3.53 4.00 4.17 4.48 4.62 3.25 3.82 4.33 4.51 4.85 5.00 3.50 4.12 4.67 4.86 5.22 5.38 3.75 4.41 5.00 5.21 5.60 5.77 4.00 4.71 5.33 5.56 5.97 6.15 4.25 5.00 5.67 5.90 6.34 6.54 4.50 5.29 6.00 6.25 6.72 6.92 4.75 5.59 6.33 6.60 7.09 7.31 5.00 5.88 6.67 6.94 7.46 7.69 5.25 6.18 7.00 7.29 7.84 8.08 5.50 6.47 7.33 7.64 8.21 8.46 5.75 6.76 7.67 7.99 8.58 8.85 6.00 7.06 8.00 8.33 8.96 9.23 This table assumes the investor is subject to federal income taxes only.
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