Tax Reform Act of 1986 Definition

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Tax Reform Act of 1986 Definition

What Is the Tax Reform Act of 1986?

The Tax Reform Act of 1986 is a piece of legislation approved by the United States Congress in order to simplify the income tax system. The Act cut the maximum rate on ordinary income and increased the tax rate on long-term capital gains to promote fairness and offer an incentive for economic development.

It was followed by the tax reform act of 1993.

Key Takeaways

  • President Ronald Reagan signed the Tax Reform Act of 1986 into law, which was a comprehensive tax reform bill.
  • The measure successfully reduced the highest marginal income tax bracket rates while closing various loopholes.
  • The 1986 reform was followed by further legislation in 1993 and afterwards.

Understanding the Tax Reform Act of 1986

The Tax Reform Act of 1986 was signed into law by Republican President Ronald Reagan on October 22, 1986. It was sponsored in Congress by Richard Gephardt (D-MO) in the House of Representatives and Bill Bradley (D-NJ) in the Senate. The legislation is often regarded as the second of two Reagan tax cuts, the first of which being the Economic Recovery Tax Act of 1981.

The Tax Reform Act of 1986 reduced the top rate on regular income from 50% to 28% while increasing the lowest rate from 11% to 15%. This was the first time in US income tax history that the highest tax rate was reduced while the lowest rate was raised.

The Tax Reform Act of 1986 also abolished the difference between long-term capital gains and ordinary income. The legislation required capital gains to be taxed at the same rate as regular income, increasing the maximum tax rate on long-term capital gains from 20% to 28%.

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Prior to the legislation, capital gains were either taxed at lower rates than ordinary income under an alternative tax or were exempt from tax under the normal rate schedule. Sixty percent of capital gains on assets held for at least six months were tax-free. Thus, under prior tax legislation, the marginal tax rate on net long-term capital gains was just 40% of the marginal tax rate on other types of income.

The Tax Reform Act of 1986, in addition to changing the tax rates, abolished numerous tax shelters. It required people claiming children as dependents to include Social Security numbers for each child on their tax returns, expanded the Alternative Minimum Tax (AMT)—the least amount of tax that an individual or corporation must pay after deducting all eligible exclusions, credits, and deductions—and increased the Home Mortgage Interest Deduction to encourage homeownership.

While the legislation repealed provisions in the tax law that permitted people to deduct interest on consumer loans, it boosted personal exemptions and standard deduction amounts and made them inflation-indexed.

The corporation tax rate has been cut from 50% to 35%. In addition, the Tax Reform Act of 1986 lowered allowances for some business costs, such as business meals, travel, and entertainment, and limited deductions for certain other expenses.

Tax Reform Act of 1993

Following that, the Clinton Administration enacted the Tax Reform Act in 1993, which included numerous key features for people, such as the inclusion of the 36% tax bracket, an increase in fuel prices, and a 10% extra tax on married couples earning more than $250,000. It also increased taxes on Social Security payouts and repealed the Medicare tax ceiling. The Tax Reform Act was one of President Clinton’s first tax packages, and it resulted in several substantial changes in tax law for people and corporations alike.

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The Tax Reform Act of 1993, also known as the Revenue Reconciliation Act of 1993, was a piece of legislation. This law has an impact on more than just individuals. For example, the corporation tax rate was increased, as was the goodwill depreciation period lengthened and the deductibility of congressional lobbying costs eliminated.

Many additional taxes were increased, and many deductions were decreased or abolished. Despite the fact that the act was signed into law on August 10, it was one of the first legislation to retrospectively boost the tax rate, thereby making the higher tax rates legal for taxpayers for the beginning of the year.

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