tax-exempt equivalent yield

To calculate the taxable equivalent yield for a tax-exempt fund, all
the sources say to use your marginal tax bracket. And I understand
their reasoning behind it, but I question whether it is truly the most
useful.

Let's take the case of a married couple filing jointly with $65K
income. The threshold between the 15% and 25% bracket is aroung $60K.
The experts say to use the marginal bracket, 25%, to calculate
tax-equivalent yield. This makes sense.

But what if you look at the bigger picture. Let's say they deduct $5000
in mortgage interest, and earn $5000 in dividends. If they deduct the
mortgage interest first, then it puts them in the 15% bracket. If they
"deduct" dividends first, then they're in the 25% bracket.

It seems to me that it would be more consistent to use the effective
tax rate. In this example, it would be 14.7%. Then it wouldn't matter
the order to calculate the deductions.

Re: tax-exempt equivalent yield

The tax is based on the AGI which would probably fall into the 15% bracket
most of the time. I would guess that most people would have to make in
excess of $70K to get into the 25% bracket. You also have to figure your
state tax (if you have one) to calculate the taxable equivalent yield.
"Bucky" <> wrote in message
news:
> To calculate the taxable equivalent yield for a tax-exempt fund, all
> the sources say to use your marginal tax bracket. And I understand
> their reasoning behind it, but I question whether it is truly the most
> useful.
>
> Let's take the case of a married couple filing jointly with $65K
> income. The threshold between the 15% and 25% bracket is aroung $60K.
> The experts say to use the marginal bracket, 25%, to calculate
> tax-equivalent yield. This makes sense.
>
> But what if you look at the bigger picture. Let's say they deduct $5000
> in mortgage interest, and earn $5000 in dividends. If they deduct the
> mortgage interest first, then it puts them in the 15% bracket. If they
> "deduct" dividends first, then they're in the 25% bracket.
>
> It seems to me that it would be more consistent to use the effective
> tax rate. In this example, it would be 14.7%. Then it wouldn't matter
> the order to calculate the deductions.
>

Re: tax-exempt equivalent yield

W. Wells wrote:
> The tax is based on the AGI which would probably fall into the 15% bracket
> most of the time. I would guess that most people would have to make in
> excess of $70K to get into the 25% bracket.

Thanks for your input. It helped shed some additional light on this. I
don't it's the AGI line though. You should use the marginal tax bracket
from the Taxable Income line, which is after deductions.

Re: tax-exempt equivalent yield

I don't know where your confusion is. No one ever said the marginal
rate was based on AGI.

Your marginal tax rate is the rate at which your last dollar of taxable
income is taxed, not the rate at which all your dollars are taxed.
Therefore, by definition, It's after all deductions and credits. You
figure taxes with the extra income and then without.

Re: tax-exempt equivalent yield

There are state taxes too. To get a truly accurate picture, you have to
run the Turbo Tax on both scenarios.

Re: tax-exempt equivalent yield

"Bucky" <> wrote in message
news:
> [...]You should use the marginal tax bracket
> from the Taxable Income line, which is after deductions.

That's line 43 of the 2005 form 1040.


Remember though, that qualified dividends and LT capital gains are taxed
separately. So you need to subtract off these two values before looking up
your tax bracket for ordinary income.

You can see this in the worksheet for "tax" - line 44 on the 2005 1040. In
the 2004 instructions, it appears under line 43 instructions; see
and scroll down to
"Qualified Dividends and Capital Gains Tax Worksheet - Line 43".

1. Taxable income (what you were using, above) xxxx
2. Qualified dividends xxxx
3 LT Capital gains xxxx
4. Total of qualified dividends and LT gains: line2+line3
xxxx
7. Taxable income - (qual.divs and cap gains): line1 - line4 yyyy

Compute tax based on line 7 (see line 16 of worksheet)

I've simplified the worksheet slightly, but that's the general idea.

--
Mark Freeland