Taxable-equivalent yield (TEY) answers one comparison question: what yield would a taxable bond need to pay to match a muni’s after-tax yield at your tax rates? Stated muni yields look lower than corporate or Treasury yields because many munis pay interest that is exempt from federal income tax (and sometimes state tax). TEY puts them on one scale. Do not run TEY on bonds that are already federally taxable municipals—product map: Taxable municipal bond basics.
Muni product basics: Municipal bonds basics. Bracket vs effective rate: Tax bracket vs effective rate. This is education for comparing quotes—not a buy recommendation.
The core federal formula
For a muni whose interest is federally tax-exempt:
TEY ≈ muni yield ÷ (1 − federal marginal tax rate)
Example: muni yield 3.0%, federal marginal rate 32% → TEY ≈ 3.0% ÷ (1 − 0.32) = 4.41%.
A taxable bond (or taxable bond fund) yielding 4.41% before federal tax would roughly match that muni’s federal after-tax income—before state taxes, NIIT, AMT quirks, and fund expenses. On individual taxables, that screener figure is often yield to maturity—confirm the quote convention.
Use your marginal ordinary rate on interest, not your average effective rate, for this sketch. Effective rate still matters for overall planning; it is the wrong plug-in for TEY.
Adding state tax (simplified)
If you buy an in-state muni that is exempt from both federal and state tax, a fuller sketch is:
TEY ≈ muni yield ÷ (1 − federal rate − state rate + federal×state interaction)
Many worksheets use:
TEY ≈ muni yield ÷ [1 − federal − state × (1 − federal)]
when state tax is deductible or when modeling the interaction—rules depend on whether you itemize and on current federal treatment of state taxes. If your state taxes out-of-state munis but exempts in-state bonds, national muni funds need a different TEY than a single-state fund.
If state tax on the taxable alternative is also material, compare after-tax on both sides rather than inflating only the muni.
What TEY does not fix
| Factor | Why TEY alone misleads |
|---|---|
| Duration / rate risk | A 2-year muni and a 12-year corporate are not substitutes even if TEY matches (Bond duration basics) |
| Credit risk | High-yield munis are not “Treasury + tax break” |
| Expenses | Fund ER reduces realized yield; compare net |
| Taxable munis / private activity | Some munis are federally taxable or AMT-preferenced |
| Account location | Tax-exempt interest inside an IRA is often wasted (Taxable vs tax-advantaged accounts) |
| Capital gains | Selling a muni fund above basis can create taxable gains even when interest was exempt |
Qualified dividends and long-term capital gains use different preferential rates—do not run equity TEY with the ordinary-income muni formula (Qualified dividends basics).
Worked example
Priya is in the 24% federal bracket, lives in a state with a 5% flat tax on interest, and itemizes enough that a simple interaction model is reasonable for illustration. She compares similar-duration options at Vanguard/Fidelity-style funds:
| Option | Stated yield | Rough after-tax sketch |
|---|---|---|
| Taxable bond fund | 4.40% | 4.40% × (1 − 0.24) = 3.34% federal-only; state still applies on the taxable interest |
| National muni fund | 3.20% | Federal TEY ≈ 3.20% ÷ (1 − 0.24) = 4.21%; if state taxes national munis at 5%, haircut the 3.20% by ~0.16 pp → ~3.04% state-adjusted |
| In-state muni fund | 2.95% | Federal + state exempt for Priya → keep ~2.95% and compare to taxable after both taxes |
Federal-only TEY made the national muni look close to the 4.40% taxable fund (4.21% vs 4.40%). After state tax on out-of-state muni interest, the national muni’s edge shrank. Priya still checks duration, credit quality, and expense ratio before choosing—and she keeps munis in taxable brokerage, not her Roth IRA (Investing basics for beginners).
Checklist
- Confirm the bond/fund interest is actually federally tax-exempt (read the factsheet).
- Plug your marginal ordinary rate—not a blogger’s.
- Adjust for state tax on in-state vs national munis.
- Match duration and credit quality before declaring a “winner.”
- Subtract fund expenses and ignore TEY inside retirement accounts for tax-exempt munis.
- Re-run TEY when you change brackets (raise, marriage, retirement).
Educational only. Not tax or investment advice. TEY is an approximation; NIIT, AMT preference items, phaseouts, and state rules can change the real ranking. Confirm with official statements, IRS materials, and a qualified professional when amounts are material.