Main / Glossary / Tax Reform Act of 1986

Tax Reform Act of 1986

The Tax Reform Act of 1986 (TRA) was a significant piece of legislation that brought about substantial changes in the United States tax code. Enacted on October 22, 1986, this comprehensive tax reform bill was enacted with the primary objective of simplifying the tax system, reducing tax rates, and broadening the tax base. The Act, signed into law by President Ronald Reagan, introduced fundamental alterations to individual income taxation, corporate taxation, and various other aspects of the tax code that had a profound impact on the field of finance, accounting, and business.

One of the key features of the Tax Reform Act of 1986 was the reduction of individual income tax rates. The Act collapsed the existing 15 income tax brackets into just two brackets, 15% and 28%, thereby simplifying the tax structure for individuals. Moreover, it also brought about modifications in the way capital gains were taxed, with long-term capital gains being subject to a maximum rate of 28%. These changes were aimed at promoting economic growth, investment, and entrepreneurship by providing individuals with greater incentives to save and invest.

In addition to the individual tax reforms, the Tax Reform Act of 1986 made significant changes to corporate taxation as well. It lowered the maximum corporate tax rate from 46% to 34% and eliminated the preferential tax treatment of capital gains earned by corporations. These modifications were intended to promote fairness and create a level playing field for businesses, discouraging the use of certain tax loopholes and encouraging corporations to focus on their core operations rather than seeking tax advantages.

One of the most significant impacts of the Tax Reform Act of 1986 was the elimination of the investment tax credit and the accelerated depreciation allowances for business equipment. Instead, the Act introduced the concept of Modified Accelerated Cost Recovery System (MACRS), which provided a more simplified and standardized method for depreciating business assets. This change aimed to remove distortions in business decision-making caused by tax incentives and promote more efficient allocation of resources.

Another crucial aspect of the Tax Reform Act of 1986 was the provisions related to passive activity losses and real estate. The Act limited the ability of taxpayers to offset losses from passive activities against income from active businesses, curtailing the use of certain tax shelters. It also introduced new tax rules for real estate investments, such as the requirement of classifying real estate activities as either active or passive for tax purposes. These changes aimed to prevent excessive tax sheltering and ensure fair treatment of different types of income.

The Tax Reform Act of 1986 represented a monumental shift in the U.S. tax landscape and had a lasting impact on the fields of finance, accounting, and business. Its provisions transformed the way individuals and corporations navigate the tax system, emphasizing simplicity, fairness, and economic efficiency. While subsequent legislation has introduced additional changes and refinements to the tax code, the Tax Reform Act of 1986 remains a landmark piece of legislation that shaped the modern U.S. tax framework.