After-Tax Comparison of USGO Funds and Bank APY for Philadelphians

[rgolds88]

I asked in the Money Market Optimizer Spreadsheet - Releases, Bugs, etc. thread (this post) about how to properly do an apples-to-apples comparison of the after-tax yield of a mutual fund containing US Government Obligations with a bank's published APY. Ordinarily, this would be done by looking at the Compound Tax Effective Yield.

The complication for residents of Philadelphia is that in addition to the flat 3.07% tax from Pennsylvania, we're also subject to the Philadelphia School Income Tax, currently 3.75% of unearned income. The SIT exempts income from USGO, as well as standard bank account interest per Section 206(b) of the SIT regulations.

retiringwhen suggested I start a new thread to get input from others like Kevin M.

Any thoughts on how to properly compare a bank's published APY with MM funds including USGO for those subject to the Philadelphia School Income Tax, which exempts interest from bank accounts, would be greatly appreciated.

[retiringwhen]

So I will try a response: See this sheet. I may not keep this one up long-term, but instead merge the core calculations into a new tab in my MM sheet.

I show the derivation of the local (Philly) version on onr tab and then provide tabs to enter fund/tax data and get comparison for "normal" investors and one for Philadelphia investors. The formulas are shown in more mathematical forms than excel style too.

https://docs.google.com/spreadsheets/d/ ... sp=sharing

[rgolds88]

So I will try a response: See this sheet. I may not keep this one up long-term, but instead merge the core calculations into a new tab in my MM sheet.

I show the derivation of the local (Philly) version on onr tab and then provide tabs to enter fund/tax data and get comparison for "normal" investors and one for Philadelphia investors. The formulas are shown in more mathematical forms than excel style too.

https://docs.google.com/spreadsheets/d/ ... sp=sharing

Thanks! I had to take a little time to digest that, and I'm still not quite sure I fully understand it (and my coffee hasn't kicked in yet...).

On the Philly tab, for a Bank APY of 5.00%, in cell B21, it shows 5.27% as the Tax-Equivalent Compound Yield (APY) for Bank Deposits. Why would that be greater than the published 5.00% APY, considering Pennsylvania's state tax rate of 3.07%, which does not exempt bank yields? I thought the Tax-Equivalent Compound Yield for a bank account should be lower than the bank's published APY where federal/state income taxes are above 0%?

[retiringwhen]

Tax-Equivalent Yields are always greater than the advertised APY when there is a tax exemption involved. This happens because when you compare an exempt return with a fully taxable return, the after tax return is higher (you paid less taxes) on the exempt fund.

BTW, I simplified just the bank deposit use case to this. It may make more sense. I derived the formula on the formulas tab by just zeroing out all the unused portions of the formula for bank deposits. It may make more sense to you:

Code: Select all

ATY	=	Y * (1-f-s)
TEY	=	Y * (1-f-s) / (1-f-s-c)

Note, the TEY for the Treasury fund is even higher because it avoids more taxes (state and local).

[retiringwhen]

Remember, an ATY (After Tax Yield) is the actual net return after taxes have been paid.
YEY (Tax-Equivalent Yield) is an artificial rate that can be compared with fully 100% taxable advertised rates.

Those are normally Bank deposit rates. But in your case, bank deposits are not 100% taxable, thus you need to adjust even that rate to have an apples to apple comparison.

[rgolds88]

Ah, ok, that does make sense - and after my coffee has kicked in a bit, I do see the Prime MM Fund with no exemptions does match the 5.00% APY as expected, while the bank yield is higher, because although it's subject to federal/state tax, it's exempt from local tax.

I guess my next question is now how to incorporate that in the MM Optimizer spreadsheet. As I'd always considered the TEY as the apples-to-apples comparison with a published bank APY, that's not actually the case for Philadelphians (or anyone else in an area that exempts bank account interest from local taxation).

I guess one way to approach it would be to add a Bank APY field in My Parameters (to enter the highest yield account you have access to or a comparison rate for a bank account you're considering opening), and add a new row for Bank Deposits in the BestNow tabs, maybe below the 1 month Treasury Bill row, so the green conditional formatting would highlight whichever has the highest ATY, TEY, etc.

[retiringwhen]

I guess one way to approach it would be to add a Bank APY field in My Parameters (to enter the highest yield account you have access to or a comparison rate for a bank account you're considering opening), and add a new row for Bank Deposits in the BestNow tabs, maybe below the 1 month Treasury Bill row, so the green conditional formatting would highlight whichever has the highest ATY, TEY, etc.

I think the latter is a good model. I am hesitant to add the local exemption model into the core sheet though as it is a very limited issue and possibly unique with other jurisdictions coming up with variations that are different enough to make this formula not work.

Just use the formulas I put in the post above and make sure the conditional formatting is correct after you add the row. I don't have a place for the local taxes to be generally defined, but you could just hard code the rates for you individual situation on the bank deposits. BTW, remember to add in the local tax rate into the State rates for the parts of my sheet to work correctly though.