J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

30.12 Investing in Tax-Exempts

Interest on state and local obligations is not subject to federal income tax. It is also exempt from the tax of the state in which the obligations are issued. In comparing the interest return of a tax-exempt with that of a taxable bond, you figure the taxable return that is equivalent to the tax-free yield of the tax-exempt. This amount depends on your tax bracket. For example, a municipal bond yielding 3% is the equivalent of a taxable yield of 4.167% subject to the tax rate of 28%.

You can compare the value of tax-exempt interest to taxable interest for your tax bracket by using this formula:

The denominator of the above fraction is:

0.85 if your tax bracket is 15%

0.75 if your tax bracket is 25%

0.72 if your tax bracket is 28%

0.67 if your tax bracket is 33%

0.65 if your tax bracket is 35%

EXAMPLE

You are deciding between a tax-exempt bond and a taxable bond. You want to find which will give you more income after taxes. You have a choice between a tax-exempt bond paying 2.5% and a taxable bond paying 3.25%. Your tax bracket is 25%.

You find that the tax-exempt bond is a slightly better buy in your tax bracket as it is the equivalent of a taxable bond paying 3.33%.

- - - - - - - - - -

Planning Reminder

Municipal Bond Funds

Instead ...