How to Calculate After Tax Bond Yield

Step-by-Step Guide

1. 1

   Step 1: Determine the type of bond.

   Bonds returns are taxed differently based upon the type of bond.
   
   There are three major types of bonds: corporate, federal government, and municipal bonds.
   
   Corporate bonds are sold by corporations and their returns are taxed like regular income (taxed at all tax levels).
   
   Federal government bonds, like treasury bills and bonds, are only taxable at the federal level.
   
   Municipal bonds, on the other hand, are tax free if purchased in your own municipality or state., The returns taxed on each type of bond are the coupon payments (interest payments) made to the bondholder throughout the life of the bond.
   
   The tax rate used on these payments is the same used to tax your income throughout the year.
   
   For example, if you are in the 33 percent tax bracket, returns on a corporate bond that you own would be taxed at 33 percent.However, you would also need to then calculate your state income tax rate and add in taxes to the state to determine your total tax burden., Whenever you sell a bond on the secondary market, you will need to pay capital gains tax on any gains made in the trade.
   
   This is true for every type of bond.
   
   Capital gains tax is different than income tax, but is still determined by your income.
   
   After-tax returns on trades can also be calculated using the after-tax bond yield calculation method described in this article., If you buy a bond at a discount, as is typically done with zero-coupon bonds (bond that don't pay interest), you need to report the discount as income.
   
   The discount will be spread out evenly over the life of the bond.
   
   This discount is then taxed as income at your income tax rate.
   
   Alternately, any bond premiums paid can be deducted from your taxable income.
   
   Premiums are any money paid above the par value of a bond., Start by calculating the annual percent return provided by the bond.
   
   This is generally spelled out when you purchase the bond.
   
   For example, a corporate bond might pay 10 percent annual interest.
   
   This can be annual, with one 10 percent payment, semiannual with two 5 percent payments, or any other number of payments throughout the year that total 10 percent of the bond's par value., Your tax rate on a bond will depend on the bond's type.
   
   See the other part of this article, "figuring out how the bond is taxed," for more information.
   
   Add up the relevant taxes for the bond to figure out your total tax rate.For example, imagine your federal tax bracket is 33 percent.
   
   Your state income tax rate is another 7 percent.
   
   So, your total tax rate for a corporate bond would be 40 percent (33 percent + 7 percent). , The after-tax yield equation is simply ATY=r∗1−t{\displaystyle ATY=r*{1-t}}.
   
   In the equation, ATY means after-tax yield, r is the pre-tax return, and t is your total tax rate for the bond.For example, the 10 percent corporate bond would be entered as ATY=0.1∗(1−0.4){\displaystyle ATY=0.1*(1-0.4)}.
   
   Note that the percentage return, 10 percent, and the tax rate, 40 percent, were entered in the equation as decimals.
   
   This is to simplify calculation.
   
   To convert percentages to decimals, simply divide by
   100. , Solve your equation by first subtracting the figures within the parentheses.
   
   In the example, this gives ATY=0.1∗(0.6){\displaystyle ATY=0.1*(0.6)}.
   
   Then, simply multiply the final two numbers to get your answer.
   
   This would be
   0.06 or 6 percent.
   
   So, your after-tax yield for a 10 percent corporate bond at a 40 percent tax rate would be 6 percent. , Tax-equivalent yield is a figure that is used to compare tax-free bond returns to returns from taxable bonds.
   
   It converts the untaxed bond's return to an imaginary "pre-tax" return so that it can be easily compared to taxable security returns.
   
   This technique is useful for comparing the returns on municipal bonds to federal government and corporate bonds., Check your records for the untaxed bond's yield.
   
   For example, imagine that you find a municipal bond that pays
   5.5 percent interest annually.
   
   This is your return that you will use for return calculations., Tax-equivalent yield is calculated using the formula TEY=r1−t{\displaystyle TEY={\frac {r}{1-t}}}.
   
   In the formula, TEY stands for tax-equivalent yield, r represents the bond's annual return in decimal form, and t is your income tax rate, also in decimal form.
   
   For example, assuming the
   5.5 percent bond described above and a 40 percent total tax rate, you would complete the equation as follows:
   TEY=0.0551−0.4{\displaystyle TEY={\frac {0.055}{1-0.4}}}.Calculate the answer by first subtracting the numbers on the bottom.
   
   Then, divide the remaining numbers to get your answer.
   
   Here, this would be
   0.055/0.6, which works out to
   0.0917 if you round to three decimal places.
   
   Your
   5.5 percent municipal bond offers the same return as a taxable bond with a stated
   9.17 percent return. , This number can now be used to compare the municipal bond's return to taxable bond returns.
   
   For example, imagine you were considering a corporate bond that offers 9 percent returns.
   
   It may seem like an easy choice to choose the corporate bond over a municipal bond offering
   5.5 percent.
   
   However, after the calculation, you can see that the municipal bond actually offers a higher return (9.17 percent over 9 percent).
2. 2

   Step 2: Use your income tax bracket for bond returns.

3. 3

   Step 3: Use capital gains tax for gains on trades.

4. 4

   Step 4: Include any discounts on bonds.

5. 5

   Step 5: Determine the pre-tax yield.

6. 6

   Step 6: Figure out the tax rate you have paid or will be charged on the bond.

7. 7

   Step 7: Input your data into the after-tax yield equation.

8. 8

   Step 8: Solve for after-tax bond yield.

9. 9

   Step 9: Understand tax-equivalent yield.

10. 10

    Step 10: Determine the yield of the untaxed bond.

11. 11

    Step 11: Calculate tax-equivalent yield.

12. 12

    Step 12: Compare this yield to a taxed security's yield.

Detailed Guide

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