The interest rate that must be received on a taxable security to provide the holder the same after-tax return as that earned on a tax-exempt bond. Because interest earned on municipal securities generally is not subject to federal income taxation, a tax-exempt bond does not have to yield to a holder as much as a taxable security to produce an equivalent after-tax yield; this differential is attributable to the effect of the tax liability incurred by the holder if it held a taxable security. The taxable equivalent yield varies according to the holder’s marginal federal income tax bracket and, where applicable, any state or local tax liability as well. The formula for determining the taxable equivalent yield is:

                                                        Tax-Exempt Yield

Taxable Equivalent Yield =   ___________________________________

                                               100% - Marginal Tax Bracket

Last updated on May 14, 2009 by Jack Parsons