Key Takeaways
- Overhauled tax code to simplify and broaden base.
- Lowered top individual rate from 50% to 28%.
- Cut corporate tax rate but broadened tax base.
- Eliminated many deductions and capital gains preferences.
What is Tax Reform Act of 1986?
The Tax Reform Act of 1986 (TRA 1986) was a major legislative overhaul of the U.S. federal tax code designed to simplify tax rates and broaden the tax base while maintaining revenue neutrality. Signed by President Ronald Reagan, it aimed to improve fairness by eliminating many deductions and special preferences that had complicated taxation for individuals and corporations alike.
This act reshaped individual and corporate taxation, including adjustments to the ability-to-pay taxation principle, to better align tax liabilities with taxpayers' true economic capacity.
Key Characteristics
TRA 1986 introduced sweeping changes that balanced tax rate reductions with base broadening to promote efficiency and fairness.
- Lower Individual Rates: Reduced the top marginal rate from 50% to 28%, while raising the lowest bracket to 15%, simplifying the tax brackets.
- Corporate Tax Adjustments: Cut the top corporate tax rate to 34% but eliminated many corporate tax preferences, affecting C corporations.
- Base Broadening: Repealed or limited many deductions such as the state and local tax (SALT) deduction, which affected taxpayers in high-tax states.
- Capital Gains Taxation: Removed preferential rates on long-term capital gains, taxing them at ordinary income rates to close loopholes.
- Alternative Minimum Tax (AMT): Strengthened to ensure high-income taxpayers and corporations paid a minimum level of tax, influencing the AMT landscape.
How It Works
TRA 1986 streamlined the tax code by reducing the number of tax brackets and lowering rates, while simultaneously expanding the tax base through the elimination of various deductions and credits. This approach ensured that overall tax revenue remained stable despite rate cuts.
By broadening the tax base and reducing preferences, the act targeted tax shelters and loopholes, making the system more equitable. For example, it phased out deductions for personal interest except for mortgage interest, encouraging home ownership and aligning with policies that affect large-cap stocks in the housing market.
Examples and Use Cases
The TRA 1986 had diverse impacts across industries and taxpayers, illustrating its broad reach and complexity.
- Airlines: Delta and other carriers adjusted to new corporate tax structures that eliminated many previous tax benefits, affecting their capital investment decisions.
- Dividend Taxation: Changes in capital gains and ordinary income rates influenced investors’ preferences for dividend stocks and impacted companies like Dividend-paying firms.
- Alternative Minimum Tax: The expansion of the AMT affected both individuals and corporations, requiring more careful tax planning to avoid unintended liabilities.
Important Considerations
When evaluating the effects of the Tax Reform Act of 1986, consider that while it simplified many aspects of the tax code, it also introduced complexities like a strengthened AMT that continue to influence tax planning today.
Understanding how the act shifted tax burdens between individuals and corporations can help you navigate current tax policies and investment decisions more effectively.
Final Words
The Tax Reform Act of 1986 significantly simplified the tax code by lowering rates and broadening the tax base, shifting some tax burdens from individuals to corporations. To optimize your tax strategy, review how these structural changes impact your current filings or investments and consider consulting a tax professional to align your approach with the reformed system.
Frequently Asked Questions
The Tax Reform Act of 1986 was a major overhaul of the U.S. federal tax code signed by President Ronald Reagan. It aimed to simplify the tax system, broaden the tax base, promote fairness, and encourage economic growth while keeping revenue roughly neutral.
Before the act, the tax code had become overly complex with many deductions and shelters, leading to inequities and inefficiencies. The 1986 reform sought to address these issues by reducing rates and eliminating many tax preferences.
The act lowered the top individual tax rate from 50% to 28% and simplified the brackets to mainly two rates: 15% and 28%. It also raised the bottom rate from 11% to 15% and adjusted personal exemptions with cost-of-living increases.
Corporate tax rates were cut from 46% to 34%, but corporations faced higher liabilities overall due to the repeal of the investment tax credit and expansion of the corporate alternative minimum tax. The act also required large corporations to use accrual accounting.
The act eliminated many deductions like state and local tax deductions and personal interest deductions, ended preferential capital gains rates, introduced passive activity loss rules, and strengthened the alternative minimum tax for individuals.
Yes, it ended the preferential treatment of capital gains by taxing long-term gains at ordinary income tax rates, starting at a maximum of 28% in 1987 and moving to 33% by 1988, eliminating the previous 60% exclusion.
By removing many tax shelters and preferences, lowering rates, and broadening the base, the act aimed to make the tax system fairer and more efficient. It shifted some tax burdens from individuals to corporations to balance revenue needs.
Yes, the act was the result of three years of bipartisan collaboration between Democrats and Republicans. It originated from proposals by Senator Bill Bradley and Representative Dick Gephardt and was supported by President Reagan.
