Receiving high yields on your investments is nice — until you have to pay the tax bill. What actually counts when considering your investment income is the after-tax yield.

Take a $1,000 investment that is paying a 5 percent yield. The $50 of interest earned each year will be reduced by the amount of tax due on that $50. So, if the owner is in a 28 percent tax bracket, that $50 is reduced by a tax of $14, for an after-tax yield of $36 or 3.6 percent.

Knowing your marginal tax rate is the first step in determining which type of interest-paying investment provides the highest after-tax yield. The higher your marginal rate, the lower your after-tax yield on an investment that pays taxable income. Using the above example, the after-tax yield on the $50 of investment income if you are in a 39.6 percent bracket would be only 3.02 percent. You can determine your marginal tax rate by looking at the rate at which your last dollar of taxable income is taxed. If you pay state income tax, the marginal rate for both federal and state purposes should be combined. Note, though, that interest on U. S. Treasury debt instruments is exempt from state taxes.

Next, you must compare the current yields on the various investment vehicles in which you are considering investing. The yields on fixed-income investments such as savings deposits, corporate bonds, municipal bonds, and U.S. Treasury securities vary depending on the maturity of the investment, the quality of the issuer, and current market interest rates, among other factors.

Choosing among these investments obviously requires more than just a consideration of yield. But once you’ve narrowed the choices down, you should then analyze the yields on an after-tax basis. For the high tax bracket investor, tax-exempt municipal securities usually offer higher yields compared to the after-tax yields on taxable securities of similar quality and maturity. This is not always the case, however, so you’ll want to apply the following formula to each taxable investment alternative: Taxable Yield x (1 – Tax Bracket) = After-tax Yield.

For instance, assume you have two investment alternatives of the same maturity and quality. The first is a tax-exempt bond that yields 6 percent and the second is a taxable bond that yields 8 percent. You are in a 36 percent tax bracket. Applying the above formula to the taxable investment, you find that the after-tax yield is 5.12 percent — that is, .08 x (1 – .36). Therefore, the tax-exempt bond provides the higher after-tax yield.

The relationship between yields on taxable and tax-exempt investments can change over time. That is one reason to go over the numbers regularly and adjust your investment portfolio as needed. In general, the higher your tax bracket, the greater the advantage of investing in tax-exempt securities.

Bill Rush Mosby Jr. is a Certified Public Accountant and partner with the accounting firm of Silas Simmons, LLP, located in Natchez.