What Is the Tax Reform Act of 1986?
Let me explain to you what the Tax Reform Act of 1986 really is—it's a piece of legislation passed by the U.S. Congress aimed at simplifying the income tax code. I see it as a move to boost fairness and encourage economic growth by cutting the maximum rate on ordinary income while increasing the tax rate on long-term capital gains. This act came before the Tax Reform Act of 1993, which I'll get to later.
Key Takeaways
You should know that the Tax Reform Act of 1986 stands as comprehensive tax reform signed into law by President Ronald Reagan. It effectively brought down the top marginal tax rates on income and closed off numerous loopholes. Remember, this 1986 reform paved the way for follow-up legislation in 1993 and beyond.
Understanding the Tax Reform Act of 1986
Signed by Republican President Ronald Reagan on October 22, 1986, the act was backed in Congress by Richard Gephardt from Missouri in the House and Bill Bradley from New Jersey in the Senate. I consider it the second of Reagan's tax cuts, following the Economic Recovery Tax Act of 1981.
What the act did was drop the top tax rate for ordinary income from 50% to 28% and lift the bottom rate from 11% to 15%. This was unprecedented in U.S. tax history—lowering the top rate and raising the bottom one simultaneously.
It also wiped out the difference between long-term capital gains and ordinary income, taxing capital gains at the same rate as ordinary income, which pushed the max rate on long-term gains to 28% from 20%.
Before this, capital gains got favorable treatment—either lower rates via an alternative tax or a 60% exclusion for assets held at least six months, meaning the effective marginal rate was just 40% of that on other income.
Beyond brackets, the act axed certain tax shelters. It made you provide Social Security numbers for dependent children on returns, broadened the Alternative Minimum Tax—which is the minimum tax owed after all deductions and credits—and boosted the Home Mortgage Interest Deduction to promote owning a home.
While it stopped deductions for interest on consumer loans, it raised personal exemptions and standard deductions, adjusting them for inflation.
For businesses, it cut the corporate tax rate from 50% to 35%. It also trimmed allowances for expenses like business meals, travel, and entertainment, and limited other deductions.
Tax Reform Act of 1993
Shifting to the Clinton era, the Tax Reform Act of 1993 brought major changes for individuals, like adding a 36% tax bracket, hiking gasoline taxes, and slapping a 10% surtax on married couples earning over $250,000. It also taxed more Social Security benefits and ditched the Medicare tax cap. This was one of Clinton's initial tax moves, altering laws significantly for people and companies.
Known also as the Revenue Reconciliation Act of 1993, it impacted more than just individuals—corporate taxes went up, goodwill depreciation periods lengthened, and deductions for lobbying Congress were eliminated.
Plenty of other taxes increased, and deductions got cut or removed. Notably, it was among the first to raise rates retroactively, applying the hikes from the year's start even though signed on August 10.
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