How to Calculate Interest Expense After Tax on a Bond

by Lee Nichols

Companies issue bonds as a way to increase operating capital. Investors purchase bonds because they typically pay twice a year, and many investors feel that they are a safer investment than stocks even though the return on a bond is typically less than most stocks. Knowing the cost of a corporation's debt can provide the investor with insight into the riskiness of a bond purchase, because high-risk companies normally pay more for their debt than a low-risk company does.

Divide your tax liability by your taxable income to determine your marginal tax rate. For example, if you expect to pay $1 million in taxes and you have taxable income of $4 million, your marginal tax rate is 25 percent.

Determine the interest rate you paid on the bond. For example, if you paid $5,000 in interest on a $100,000 bond, divide $5,000 by $100,000 to calculate that you paid 5-percent interest on the bond.

Multiply the interest rate by 1 minus your marginal tax rate. For example, if the marginal tax rate is 25 percent, 1 minus 25 percent is 0.75. Multiply this amount by your interest rate of 5 percent to determine that your after-tax interest rate is 3.75 percent.

Multiply your after-tax interest rate by the amount of interest paid to determine your after-tax interest expense. For example, if you paid $5,000 interest and your after-tax interest rate is 3.75 percent, your after-tax interest expense is $140.63.

Warning

  • Do not rely solely on a company's debt expense when deciding to purchase its bonds. Consult a financial adviser if you have questions about investing.