Capital Gain Yielding Bonds Produce Higher Than Expected After Tax Bonds Yields.

This article advocates and illustrates that bond investment decisions should be based on after-tax yields calculated in a way to consider that different types of income are involved and are taxed at different rates and that there is time value to deferred taxation of capital gain income. This article also describes the financial characteristics of the bond market, discusses the federal tax treatment of bonds, and concludes that taxable bonds, when selling for a discount, are far more competitive after tax than is generally believed. Probably, fewer investors should be investing in municipal bonds to maximize their after-tax yield. Municipal bonds lose some of their comparative luster over taxable bonds when one becomes cognizant of the following: 1. A portion of municipal bond yield can be subject to taxation as long-term capital gains when purchased at a market discount. 2. A portion of the yield of taxable bonds can be represented by long-term capital gains. 3. The tax on the long-term capital gain yield for both municipal and taxable bonds is deferred to the date of disposition or maturity. 4. The Revenue Act of 1978 lowered the tax on long-term capital gains; therefore, the after-tax yield on bonds generating capital gains will increase. 5. The Revenue Act of 1978 lowered somewhat the regular tax rates for both individuals and corporations.