Tax Insights

Your Guide to State, Local, Federal, Estate + International Taxation

Tax Planning – After-Tax Yield of Taxable Investments Part 2

As many investors recognize, the disadvantage of having a low stated rate of interest paid on a tax-free municipal bond is often times more than offset by the advantage of the income being earned free of taxation.  And in some cases free of state taxation as well.  But that is not always the case.  You still should crunch the numbers to determine the after-tax yield of taxable investments to see how they compare to tax free yields.  The after-tax yield of taxable investments can be determined using one of the following formulas:

If you are not itemizing your deductions and therefore do not take a deduction for state income taxes paid, the after-tax yield is equal to the pretax yield times 1 minus the combined state and federal tax rate.  For example.  Say you have a taxable bond that pays 8% and you are in a combined 39% tax bracket.  The after-tax yield of the 8% taxable bond is 4.88% (0.08 x [1 – 0.39])

If you itemize your deductions and claim a deduction for state income taxes paid, the after-tax yield is equal to the pretax yield times 1 minus the combined state and federal tax rate plus the federal tax rate times the state tax rate.  For example.  Assume the same 8% bond and combined 39% tax bracket made up of 35% federal tax rate and 4% state tax rate.  The after-tax yield of the 8% taxable bond is 4.99% (0.08 x [1 – 0.39 + (0.35 x 0.04)]

Dale Jensen, CPA