Tax Reform Act of 1986

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President Ronald Reagan signs the Tax Reform Act of 1986 on the South Lawn.

The U.S. Congress passed the Tax Reform Act (TRA) of 1986, (Pub.L. 99-514, 100 Stat. 2085, October 22, 1986) to simplify the income tax code, broaden the tax base and eliminate many tax shelters and other preferences. Although often referred to as the second of the two "Reagan tax cuts" (the Kemp-Roth Tax Cut of 1981 being the first), the bill was actually officially sponsored by two liberal Democrats, Richard Gephardt of Missouri in the House of Representatives and Bill Bradley of New Jersey in the Senate.

1 Income tax rates
2 Tax incentives
3 Passive losses and tax shelters
4 Name change for the Internal Revenue Code
5 External links

[edit] Income tax rates

The top tax rate was lowered from 50% to 28% while the bottom rate was raised from 11% to 15% - the only time in the history of the U.S. income tax (which dates back to the passage of the Revenue Act of 1862) that the top rate was reduced and the bottom rate increased concomitantly. In addition, capital gains faced the same tax rate as ordinary income. Moreover, interest on consumer loans such as credit card debt, and state and local sales or income taxes was no longer deductible. An existing provision in the tax code, called Income Averaging, which reduced taxes for those only recently making a much higher salary than before was eliminated. The law, however, increased the personal exemption and standard deduction.

[edit] Tax incentives

The Act also increased incentives favoring investment in owner-occupied housing relative to rental housing by increasing the Home Mortgage Interest Deduction. The imputed income an owner receives from an investment in owner-occupied housing has always escaped taxation, much like the imputed income someone receives from doing his own cooking instead of hiring a chef, but the Act changed the treatment of imputed rent, local property taxes, and mortgage interest payments to favor homeownership, while phasing out many investment incentives for rental housing. To the extent that low-income people may be more likely to live in rental housing than in owner-occupied housing, this provision of the Act could have had the tendency to decrease the new supply of housing accessible to low-income people. The Low-Income Housing Tax Credit was added to the Act to provide some balance and encourage investment in multifamily housing for the poor.

[edit] Passive losses and tax shelters

By enacting 26 U.S.C. § 469 (relating to limitations on deductions for passive activity losses and limitations on passive activity credits) to remove many tax shelters, especially for real estate investments, the Act significantly decreased the value of many such investments which had been held more for their tax-advantaged status than for their inherent profitability. This may have contributed to the end of the real estate boom of the early to mid '80s as well as to the Savings and Loan crisis. Some economists consider the net long-term effect of eliminating tax shelters and other distortions to be positive for the economy, by redirecting money to the most inherently profitable investments.

[edit] Name change for the Internal Revenue Code

Section 2(a) of the Act also officially changed the name of the Internal Revenue Code from the Internal Revenue Code of 1954 to the Internal Revenue Code of 1986. Although the Act made numerous amendments to the Code, it was not a substantial re-codification or reorganization of the overall structure of the Code.