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You can also adjust for state taxes being deductible from federal taxes. Exempting interest income from state taxes lowers your deduction and raises your federal tax. Assume your marginal federal tax bracket is 28%

5 / (1 - 0.053(1 - 0.28)) = 5 / (1 - 0.053(.72)) = 5 / (1 - 0.038) = 5.20

A darn good point.

Luckily I don't itemize at this point, so it doesn't apply to me, but you just gave me another thing to think about.

For those that do itemize, the change here is that your state taxes are tax deducitle (as Vicki made clear), which created a concept that I'll call "marginal net state tax rate".

With our 5.3% state tax and me in the 25% federal bracket, that's 5.3%(1-25%), which is right about 4% (3.975% to be precise). If I was to itemize, then that is the marginal state tax rate I'd really pay, and *that* is the number that should be used as the state tax rate in the tax-equivalent yield formula.

5% / (1-.03975), which, as Viki said, is right around 5.2%.

Wow, learn something new everyday :)
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