Definition
The term Tax Reform Act of 1986 refers to a law that attempted to simplify the federal income tax code and eliminate loopholes. The Tax Reform Act of 1986 was the second of two tax cuts during the Reagan administration, with the most notable change being the lowering of the top tax bracket from 50% to 28%.
Explanation
Also known as TRA 86, the primary objective of the Tax Reform Act of 1986 was to simplify federal income tax law. At the time, TRA 86 was considered the most significant change to tax law in over 50 years. Several of the highlights of the new tax code included:
Individuals
Tax Brackets: the total number of tax brackets was reduced from fifteen to three, with the top tax rate declining from 50% to 28%, while the lowest rate increased from 11% to 15%.
Dependents: Social Security numbers were now required for all children claimed as dependents.
Capital Gains: the exclusion for income derived from long-term capital gains was eliminated; effectively treating such gains as ordinary income.
Individual Retirement Accounts: retained the $2,000 annual contribution limit, but phased out the deductibility of contributions for households based on income, if also covered by a pension plan at work.
Consumer Debt: loans such as interest payments on credit card debt were no longer deductible.
Passive Losses: deductions for business losses associated with passive activities were phased out.
Corporations
Tax Brackets: the top tax rate was reduced from 46% to 34%, while the lowest rate for businesses with less than $100,000 in income was 15%.
Alternative Minimum Tax (AMT): income subject to AMT was expanded to include a portion of economic income that had been excluded.
General Utilities Doctrine: the allowance for certain tax-free distributions of corporate assets as part of a liquidation was repealed.
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