Tax Reform Act of 1986

Tax Reform Act of 1986

The Tax Reform Act of 1986 is a law passed by the United States Congress to simplify the income tax code. Thus, the marginal tax rate on net long-term capital gains was only 40% of the marginal tax rate on other forms of income under the previous tax laws. The Tax Reform Act of 1986 lowered the top tax rate for ordinary income from 50% to 28% and raised the bottom tax rate from 11% to 15%. The Clinton Administration subsequently created the Tax Reform Act in 1993 to contain several major provisions for individuals, such as the addition of the 36% tax bracket, an increase in gasoline taxes, and an additional tax of 10 percent on married couples with income above $250,000. To increase fairness and provide an incentive for growth in the economy, the passage of the Act reduced the maximum rate on ordinary income and raised the tax rate on long-term capital gains.

The Tax Reform Act of 1986 was a comprehensive tax reform legislation that was passed into law by President Ronald Reagan.

What Is the Tax Reform Act of 1986?

The Tax Reform Act of 1986 is a law passed by the United States Congress to simplify the income tax code. To increase fairness and provide an incentive for growth in the economy, the passage of the Act reduced the maximum rate on ordinary income and raised the tax rate on long-term capital gains.

It was followed by the tax reform act of 1993.

The Tax Reform Act of 1986 was a comprehensive tax reform legislation that was passed into law by President Ronald Reagan.
The law effectively lowered the top marginal tax bracket income tax rates while eliminating several loopholes.
The 1986 reform was followed up by subsequent bills in 1993 and later.

Understanding the Tax Reform Act of 1986

Signed into law by Republican President Ronald Reagan on October 22, 1986, the Tax Reform Act of 1986 was sponsored in Congress by Richard Gephardt (D-MO) in the House of Representatives and Bill Bradley (D-NJ) in the Senate. The act is commonly known to be the second of two Reagan tax cuts, the first being the Economic Recovery Tax Act of 1981.

The Tax Reform Act of 1986 lowered the top tax rate for ordinary income from 50% to 28% and raised the bottom tax rate from 11% to 15%. This was the first time in U.S. income tax history that the top tax rate was lowered and the bottom rate was increased at the same time.

The Tax Reform Act of 1986 also provided for the elimination of the distinction between long-term capital gains and ordinary income. The act mandated that capital gains be taxed at the same rate as ordinary income, raising the maximum tax rate on long-term capital gains to 28% from 20%.

Prior to the passing of the act, capital gains were either taxed at lower rates than ordinary income under an alternative tax or received a partial exclusion from tax under the regular rate schedule. Sixty percent of capital gains on assets held for at least six months were excluded from taxable income. Thus, the marginal tax rate on net long-term capital gains was only 40% of the marginal tax rate on other forms of income under the previous tax laws.

While the act ended tax code provisions that allowed individuals to deduct interest on consumer loans, it increased personal exemptions and standard deduction amounts indexed to inflation.

For businesses, the corporate tax rate was reduced from 50% to 35%. The Tax Reform Act of 1986 also reduced the allowances for certain business expenses, such as business meals, travel, and entertainment, and restricted deductions for certain other expenses.

Tax Reform Act of 1993

The Clinton Administration subsequently created the Tax Reform Act in 1993 to contain several major provisions for individuals, such as the addition of the 36% tax bracket, an increase in gasoline taxes, and an additional tax of 10 percent on married couples with income above $250,000. It also raised taxes on Social Security benefits and eliminated the tax cap on Medicare. The Tax Reform Act was one of President Clinton’s first tax packages, and it led to a lot of significant changes in tax law for both individuals and businesses.

The Tax Reform Act of 1993 was a piece of legislation is also known as the Revenue Reconciliation Act of 1993. Individuals were not the only ones affected by this legislation. For instance, the corporate tax rate was raised as well, along with a lengthening of the goodwill depreciation period and the elimination of deductibility for congressional lobbying expenses.

Many other taxes were raised and deductions reduced or eliminated as well. The act was also one of the first bills to retroactively raise the tax rate, effectively making the increased tax rates law for taxpayers for the beginning of the year, despite the fact that the act was signed into law on August 10.

Related terms:

Alternative Minimum Tax (AMT)

An alternative minimum tax (AMT) places a floor on the percentage of tax that a filer may be required to pay to the government. read more

Business Expenses

Business expenses are costs incurred in the ordinary course of business. Business expenses are deductible and are always netted against business income. read more

Capital Gains Tax

A capital gains tax is a levy on the profit that an investor gains from the sale of an investment such as stock shares. Here's how to calculate it. read more

Corporate Tax

A corporate tax is tax on the profits of a corporation that generate revenue for a government. read more

Economic Recovery Tax Act of 1981 (ERTA)

The Economic Recovery Tax Act of 1981 was a law for the largest tax cut in American history. Much of it was reversed a year later. read more

Mortgage Interest Deduction

A mortgage interest deduction allows homeowners to deduct mortgage interest from taxable income. Read who benefits from a mortgage interest deduction. read more

Long-Term Capital Gain or Loss

A long-term capital gain or loss comes from a qualifying investment that was owned for longer than 12 months before being sold.  read more

Marginal Tax Rate

The marginal tax rate is the tax rate you pay on an additional dollar of income. read more

Medicare

Medicare is a U.S. government program providing healthcare insurance to individuals 65 and older or those under 65 who meet eligibility requirements. read more

Ordinary Dividends

Ordinary dividends are regular payments made by a company to shareholders that are taxed as ordinary income. read more