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What is tax-equivalent yield (TEY)?

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Interest income from municipal bonds is not subject to US federal income tax and generally not subject to state and local taxation in the state of issuance.  The tax-equivalent yield (TEY) is the pretax yield of a fully taxable bond used to determine the yield it must offer after taxes in order to yield as much as the municipal bond.  The after-tax yield of a taxable bond is compared to the tax-free yield of a municipal bond, where TEY is tax-equivalent yield, MBY is municipal bond yield, and MTR is marginal tax rate:

TEY = MBY/(1 – MTR)

Alternatively, if the taxable bond yield is known, the required minimum yield on the muni can be determined, where MBY is municipal bond yield, TBY is taxable bond yield, and MTR is marginal tax rate:

MBY = TBY x (1 – MTR)

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