Tax Reform Act of 1986

Definition

The Tax Reform Act of 1986 was a significant piece of legislation that aimed to simplify the tax code, broaden the tax base, and eliminate many tax shelters while lowering individual and corporate tax rates. This act was pivotal in reshaping the U.S. tax system by reducing the number of tax brackets and making it less complicated for taxpayers, thus influencing both personal and business tax regulations.

5 Must Know Facts For Your Next Test

1. The act reduced the number of individual tax brackets from 15 to 2, with rates set at 15% and 28%.
2. Corporate tax rates were also lowered from a maximum rate of 46% to 34%.
3. It eliminated many deductions and credits, significantly impacting high-income earners and investors who previously relied on these tax breaks.
4. The act intended to reduce tax avoidance strategies, particularly those associated with real estate and other investments that used shelters to lower taxable income.
5. The Tax Reform Act of 1986 is often viewed as one of the most comprehensive overhauls of the U.S. tax code since the introduction of the income tax.

Review Questions

• How did the Tax Reform Act of 1986 simplify the U.S. tax system for individuals and businesses?
  • The Tax Reform Act of 1986 simplified the U.S. tax system by reducing the number of individual tax brackets from 15 to just 2, making it easier for taxpayers to calculate their taxes owed. Additionally, it lowered both individual and corporate tax rates while eliminating numerous deductions and credits that complicated the filing process. This simplification aimed to create a more straightforward system that was less burdensome for taxpayers and businesses alike.
• What impact did the Tax Reform Act of 1986 have on capital gains taxation compared to prior regulations?
  • Before the Tax Reform Act of 1986, capital gains were taxed at lower rates than ordinary income, which encouraged various investment strategies. The act brought significant changes by raising the maximum capital gains tax rate from 20% to align more closely with ordinary income tax rates. This shift aimed to eliminate preferential treatment for capital gains and promote a fairer taxation approach among different income types.
• Evaluate the long-term effects of the Tax Reform Act of 1986 on business loss limitations and overall economic behavior.
  • The Tax Reform Act of 1986 had lasting effects on how businesses handle losses. By eliminating many shelters that previously allowed companies to offset income with losses excessively, it altered investment strategies significantly. Over time, this created a more transparent environment regarding business earnings and losses, encouraging companies to focus on sustainable growth rather than relying on complex strategies for minimizing taxes. Ultimately, this shift promoted healthier economic behaviors within the business landscape.

Related terms

Tax Shelters: Investment strategies that reduce or defer taxable income, often exploited to minimize tax liabilities before the reforms in the 1986 act.

Tax Brackets: Divisions in the tax code that determine how much tax an individual owes based on their income level, which were simplified by the 1986 act.

Capital Gains Tax: A tax on the profit realized from the sale of non-inventory assets, which saw changes due to adjustments made in the Tax Reform Act of 1986.