Municipal bonds are not generally subject to federal tax, and typically, if an in-state, taxpaying resident purchases a muni issued by an entity of that same state, then that resident would also be exempt from state and local taxes on that issuance. However, if a resident of, say, Iowa sets out to purchase a Maine GO, then state and local taxes would apply.<\/p>\n
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Meanwhile, corporate bonds are subject to both federal and state taxes.<\/p>\n
Please note that the following yield comparison calculation examples involve knowledge of your tax bracket.<\/em><\/p>\n 1. Find the net, after-tax yield of a corporate bond:<\/strong><\/p>\n Let\u2019s take a 5.0% Maine GO and compare it to a similar-maturity 2.45% Colgate-Palmolive bond, and for simplicity, we\u2019ll compare both at par. Let\u2019s also say for illustration purposes that your tax bracket is 22%.<\/p>\n To determine the net, after-tax return of the corporate bond, first subtract the illustrative tax bracket from 100%, giving 78%. Then, multiply this by the corporate bond\u2019s coupon.<\/p>\n We can then say that this Colgate-Palmolive bond is equivalent to a municipal bond yielding a little more than 1.9%.<\/p>\n 2. Find the taxable equivalent yield of a municipal bond (in-state):<\/strong><\/p>\n If a Maine resident in the 22% tax bracket buys a 5.0% Maine GO at par, there is no state tax applied since it is an in-state purchase.<\/p>\n The 5% bond is divided by 78% to give a taxable equivalent yield.<\/p>\n <\/p>\n 3. Find the taxable equivalent yield of a municipal bond (out-of-state):<\/strong><\/p>\n Now, if a taxpayer residing in a different state, say Iowa, purchased the bond, and was, again for illustrative purposes, subject to a 2% state tax, then the federal and state taxes would be combined and subtracted from 100%. We would then divide 5% by 76%.<\/p>\n 4. Compare yields across instruments:<\/strong><\/p>\n If the Colgate-Palmolive bond yielded 6% at par, the 5% Maine GO used in the calculations above would offer a higher tax-equivalent yield in both the in-state and out-of-state cases.<\/p>\n However, as described above, at 1.91%, the Colgate-Palmolive bond is far more expensive than the 5.0% Maine GO yielding 6.41% (in-state) and 6.58% (out-of-state).<\/p>\n <\/p>\n <\/p>\n","protected":false},"excerpt":{"rendered":" Interactive Brokers’ senior market analyst Steven Levine explores how to compare the yields of a taxable corporate bond with a tax-exempt municipal security on both an in-state and out-of-state basis. This due diligence lesson is the second of three parts in the U.S. Municipal Bond Market video series, available at IBKR Traders’ Academy.<\/p>\n","protected":false},"author":899,"featured_media":181009,"parent":0,"comment_status":"open","ping_status":"closed","template":"","meta":{"_acf_changed":false,"footnotes":""},"contributors-categories":[13576],"traders-academy":[13125,13128,13132],"class_list":{"0":"post-175329","1":"trading-lessons","2":"type-trading-lessons","3":"status-publish","4":"has-post-thumbnail","6":"contributors-categories-interactive-brokers","7":"traders-academy-beginner-trading","8":"traders-academy-level","9":"traders-academy-trading-lesson"},"pp_statuses_selecting_workflow":false,"pp_workflow_action":"current","pp_status_selection":"publish","acf":[],"yoast_head":"\n![\"\"](\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/01\/muni-bonds_lesson-8_2.jpg\")
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