As of July 26, 2011, the interest rate for a 20 year, A-rated Municipal bond was 5.0%. Assuming that your marginal tax rate is 25%, what would be the tax free equivalent rate on an A-rated, 20 year corporate bond?
To calculate the tax-free equivalent rate on a corporate bond, you need to determine the taxable yield that would be required to equal the tax-advantaged yield of the municipal bond.
Here are the steps to calculate the tax-free equivalent rate:
1. Subtract your marginal tax rate from 1 (1 - 0.25 = 0.75).
2. Divide the interest rate of the municipal bond by the result from step 1 (5.0% / 0.75 = 6.67%).
In this case, the tax-free equivalent rate on an A-rated, 20-year corporate bond would be approximately 6.67%.
Please note that this calculation assumes that the interest income from the municipal bond is exempt from federal income taxes, while the interest income from the corporate bond is subject to taxes at your marginal tax rate. Additionally, this calculation does not take into account state and local taxes, so the actual tax-free equivalent rate may vary depending on your specific tax situation.