Tax Reform Act Of 1986
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The Tax Reform Act of 1986 (TRA) was passed by the
99th United States Congress The 99th United States Congress was a meeting of the legislative branch of the United States federal government, composed of the United States Senate and the United States House of Representatives. It met in Washington, D.C., from January 3, 1 ...
and signed into law by President
Ronald Reagan Ronald Wilson Reagan ( ; February 6, 1911June 5, 2004) was an American politician, actor, and union leader who served as the 40th president of the United States from 1981 to 1989. He also served as the 33rd governor of California from 1967 ...
on October 22, 1986. The Tax Reform Act of 1986 was the top domestic priority of President Reagan's second term. The act lowered federal income tax rates, decreasing the number of tax brackets and reducing the top tax rate from 50 percent to 28 percent. The act also expanded the
earned income tax credit The United States federal earned income tax credit or earned income credit (EITC or EIC) is a refundable tax credit for low- to moderate-income working individuals and couples, particularly those with children. The amount of EITC benefit depends ...
, the standard deduction, and the personal exemption, removing approximately six million lower-income Americans from the tax base. Offsetting these cuts, the act increased the
alternative minimum tax The alternative minimum tax (AMT) is a tax imposed by the United States federal government in addition to the regular income tax for certain individuals, estates, and trusts. As of tax year 2018, the AMT raises about $5.2 billion, or 0.4% of all ...
and eliminated many tax deductions, including deductions for rental housing,
individual retirement account An individual retirement account (IRA) in the United States is a form of pension provided by many financial institutions that provides tax advantages for retirement savings. It is a trust that holds investment assets purchased with a taxpayer's ear ...
s, and
depreciation In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the a ...
. Although the tax reform was projected to be revenue-neutral, it was popularly referred to as the second round of
Reagan tax cuts The phrase Reagan tax cuts refers to changes to the United States federal tax code passed during the presidency of Ronald Reagan. There were two major tax cuts: The Economic Recovery Tax Act of 1981 and the Tax Reform Act of 1986. The tax cuts popul ...
(following the
Economic Recovery Tax Act of 1981 The Economic Recovery Tax Act of 1981 (ERTA), or Kemp–Roth Tax Cut, was an Act that introduced a major tax cut, which was designed to encourage economic growth. The federal law enacted by the 97th US Congress and signed into law by US Preside ...
). The bill passed with majority support in both the
House of Representatives House of Representatives is the name of legislative bodies in many countries and sub-national entitles. In many countries, the House of Representatives is the lower house of a bicameral legislature, with the corresponding upper house often c ...
and the
Senate A senate is a deliberative assembly, often the upper house or chamber of a bicameral legislature. The name comes from the ancient Roman Senate (Latin: ''Senatus''), so-called as an assembly of the senior (Latin: ''senex'' meaning "the el ...
, receiving the votes of majorities among both congressional Republicans and
Democrat Democrat, Democrats, or Democratic may refer to: Politics *A proponent of democracy, or democratic government; a form of government involving rule by the people. *A member of a Democratic Party: **Democratic Party (United States) (D) **Democratic ...
s, including Democratic Speaker of the House
Tip O'Neill Thomas Phillip "Tip" O'Neill Jr. (December 9, 1912 – January 5, 1994) was an American politician who served as the 47th speaker of the United States House of Representatives from 1977 to 1987, representing northern Boston, Massachusetts, as ...
.


Passage

After his victory in the 1984 presidential election, President
Ronald Reagan Ronald Wilson Reagan ( ; February 6, 1911June 5, 2004) was an American politician, actor, and union leader who served as the 40th president of the United States from 1981 to 1989. He also served as the 33rd governor of California from 1967 ...
made simplification of the tax code the central focus of his second term domestic agenda. Working with
Speaker of the House The speaker of a deliberative assembly, especially a legislative body, is its presiding officer, or the chair. The title was first used in 1377 in England. Usage The title was first recorded in 1377 to describe the role of Thomas de Hungerf ...
Tip O'Neill Thomas Phillip "Tip" O'Neill Jr. (December 9, 1912 – January 5, 1994) was an American politician who served as the 47th speaker of the United States House of Representatives from 1977 to 1987, representing northern Boston, Massachusetts, as ...
, a Democrat who also favored tax reform, Reagan overcame significant opposition from members of Congress in both parties to pass the Tax Reform Act of 1986.


Income tax rates

The top tax rate for individuals for tax year 1987 was lowered from 50% to 33%. Many lower level tax brackets were consolidated, and the upper income level of the bottom rate (married filing jointly) was increased from $5,720/year to $29,750/year. This package ultimately consolidated tax brackets from fifteen levels of income to four levels of income. The standard deduction, personal exemption, and
earned income credit The United States federal earned income tax credit or earned income credit (EITC or EIC) is a refundable tax credit for low- to moderate-income working individuals and couples, particularly those with children. The amount of EITC benefit depends ...
were also expanded, resulting in the removal of six million poor Americans from the income tax roll and a reduction of income tax liability across all income levels. The higher standard deduction substantially simplified the preparation of tax returns for many individuals. For tax year 1987, the Act provided a graduated rate structure of 15%/28%/33%. Beginning with tax year 1988, the Act provided a nominal rate structure of 15%/28%/33%. However, beginning with 1988, taxpayers having taxable income higher than a certain level were taxed at an effective rate of about 28%. This was jettisoned in the
Omnibus Budget Reconciliation Act of 1990 The Omnibus Budget Reconciliation Act of 1990 (OBRA-90; ) is a United States statute enacted pursuant to the budget reconciliation process to reduce the United States federal budget deficit. The Act included the Budget Enforcement Act of 1990 whic ...
, otherwise known as the "Bush tax increase", which violated his
Taxpayer Protection Pledge Americans for Tax Reform (ATR) is a politically conservative U.S. advocacy group whose stated goal is "a system in which taxes are simpler, flatter, more visible, and lower than they are today." According to ATR, "The government's power to contr ...
.


Tax incentives

The Act also increased incentives favoring investment in owner-occupied housing relative to rental housing. Prior to the Act, all personal interest was deductible. Subsequently, only home mortgage interest was deductible, including interest on home equity loans. The Act phased out many investment incentives for rental housing, through extending the depreciation period of rental property to 27.5 years from 15–19 years. It also discouraged real estate investing by eliminating the deduction for passive losses. 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 The Low-Income Housing Tax Credit (LIHTC - often pronounced "lie-tech", Housing Credit) is a dollar-for-dollar tax credit in the United States for affordable housing investments. It was created under the Tax Reform Act of 1986 (TRA86) and gives ...
was added to the Act to provide some balance and encourage investment in multifamily housing for the poor. Moreover, interest on consumer loans such as credit card debt 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 (although later partially reinstated, for farmers in 1997 and for fishermen in 2004). The Act, however, increased the personal exemption and standard deduction. The
individual retirement account An individual retirement account (IRA) in the United States is a form of pension provided by many financial institutions that provides tax advantages for retirement savings. It is a trust that holds investment assets purchased with a taxpayer's ear ...
(IRA) deduction was severely restricted. The IRA had been created as part of the Employee Retirement Income Security Act of 1974, where employees not covered by a pension plan could contribute the lesser of $1500 or 15% of earned income. The
Economic Recovery Tax Act of 1981 The Economic Recovery Tax Act of 1981 (ERTA), or Kemp–Roth Tax Cut, was an Act that introduced a major tax cut, which was designed to encourage economic growth. The federal law enacted by the 97th US Congress and signed into law by US Preside ...
(ERTA) removed the pension plan clause and raised the contribution limit to the lesser of $2000 or 100% of earned income. The 1986 Tax Reform Act retained the $2000 contribution limit, but restricted the deductibility for households that have pension plan coverage and have moderate to high incomes. Non-deductible contributions were allowed.
Depreciation In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the a ...
deductions were also curtailed. Prior to ERTA, depreciation was based on "useful life" calculations provided by the Treasury Department. ERTA set up the "accelerated cost recovery system" (ACRS). This set up a series of useful lives based on three years for technical equipment, five years for non-technical office equipment, ten years for industrial equipment, and fifteen years for real property. TRA86 lengthened these lives, and lengthened them further for taxpayers covered by the alternative minimum tax (AMT). These latter, longer lives approximate "economic depreciation," a concept economists have used to determine the actual life of an asset relative to its economic value. Defined contribution (DC) pension contributions were curtailed. The law prior to TRA86 was that DC pension limits were the lesser of 25% of compensation or $30,000. This could be accomplished by any combination of elective deferrals and profit sharing contributions. TRA86 introduced an elective deferral limit of $7000, indexed to inflation. Since the profit sharing percentage must be uniform for all employees, this had the intended result of making more equitable contributions to 401(k)'s and other types of DC pension plans. The 1986 Tax Reform Act introduced the General Nondiscrimination rules which applied to qualified pension plans and 403(b) plans that for private sector employers. It did not allow such pension plans to discriminate in favor of highly compensated employees. A highly compensated employee for the purposes of testing a plan's compliance for the 2006 plan year is any employee whose compensation exceeded $95,000 in the 2005 plan year. Therefore, all new hires are by definition nonhighly compensated employees. A plan could not give benefits or contributions on a more favorable basis for the highly compensated employees if it cannot pass the minimum coverage test and the minimum participation test.


Fraudulent dependents

The Act required people claiming children as dependents on their tax returns to obtain and list a Social Security number for every claimed child, to verify the child's existence. Before this act, parents claiming
tax deduction Tax deduction is a reduction of income that is able to be taxed and is commonly a result of expenses, particularly those incurred to produce additional income. Tax deductions are a form of tax incentives, along with exemptions and tax credits. T ...
s were on the
honor system An honor system or honesty system is a philosophical way of running a variety of endeavors based on trust, honor, and honesty. Something that operates under the rule of the "honor system" is usually something that does not have strictly enf ...
not to lie about the number of children they supported. The requirement was phased in, and initially Social Security numbers were required only for children over the age of 5. During the first year, this anti-fraud change resulted in seven million fewer dependents being claimed, nearly all of which are believed to have involved either children that never existed, or tax deductions improperly claimed by non-custodial parents.


Changes to the AMT

The original
alternative minimum tax The alternative minimum tax (AMT) is a tax imposed by the United States federal government in addition to the regular income tax for certain individuals, estates, and trusts. As of tax year 2018, the AMT raises about $5.2 billion, or 0.4% of all ...
targeted tax shelters used by a few wealthy households. However, the Tax Reform Act of 1986 greatly expanded the AMT to aim at a different set of deductions that most Americans receive. Things like the personal exemption, state and local taxes, the standard deduction, private activity bond interest, certain expenses like union dues and even some medical costs for the seriously ill could now trigger the AMT. In 2007, the New York Times reported, "A law for untaxed rich investors was refocused on families who own their homes in high tax states."


Passive losses and tax shelters

(relating to limitations on deductions for passive activity losses and limitations on passive activity credits) removed many
tax shelters Tax shelters are any method of reducing taxable income resulting in a reduction of the payments to tax collecting entities, including state and federal governments. The methodology can vary depending on local and international tax laws. Types of ...
, especially for real estate investments. This contributed to the end of the real estate boom of the early-to-mid 1980s, which in turn was the primary cause of the U.S. savings and loan crisis. Prior to 1986, passive investors were able to use real estate losses to offset taxable income. When losses from these deals were no longer able to be deducted, many investors sold their assets, which contributed to sinking real estate prices. To help small landlords, The Tax Reform Act of 1986 included a temporary $25,000 net rental loss deduction, provided that the property was not personally used for the greater of 14 days or 10% of rental days, and adjusted gross income was less than $100,000.


Tax treatment of technical service firms employing certain professionals

The Internal Revenue Code does not contain any definition or rules dealing with the issue of when a worker should be characterized for tax purposes as an employee, rather than as an independent contractor. The tax treatment depends on the application of (20) factors provided by common law, which varies by state. Introduced by
Senator A senate is a deliberative assembly, often the upper house or chamber of a bicameral legislature. The name comes from the ancient Roman Senate (Latin: ''Senatus''), so-called as an assembly of the senior (Latin: ''senex'' meaning "the el ...
Daniel Patrick Moynihan, Section 1706 added a subsection (d) to Section 530 of the
Revenue Act of 1978 The United States Revenue Act of 1978, , amended the Internal Revenue Code by reducing individual income taxes (widening tax brackets and reducing the number of tax rates), increasing the personal exemption from $750 to $1,000, reducing corporate ...
, which removed "safe harbor" exception for independent contractor classification (which at the time avoided payroll taxes) for workers such as engineers, designers, drafters, computer professionals, and "similarly skilled" workers. If the IRS determines that a third-party intermediary firm's worker previously treated as self-employed should have been classified as an employee, the IRS assesses substantial back taxes, penalties and interest on that third-party intermediary company, though not directly against the worker or the end client. It does not apply to individuals directly contracted to clients. The change in the tax code was expected to offset tax revenue losses of other legislation Moynihan proposed that changed the law on foreign taxes of Americans working abroad. At least one firm simply adapted its business model to the new regulations. A 1991 Treasury Department study found that tax compliance for technology professionals was among the highest of all self-employed workers and that Section 1706 would raise no additional tax revenue and could possibly result in losses as self-employed workers did not receive as many tax-free benefits as employees. In one report in 2010, Moynihan's initiative was labeled "a favor to IBM.""Tax Law Was Cited in Software Engineer’s Suicide Note"
by David Kay Johnston, ''The New York Times'', February 18, 2010. Retrieved 2010-06-17. A suicide note by software professional Joseph Stack, who flew his airplane into a building housing IRS offices in February 2010, blamed his problems on many factors, including the Section 1706 change in the tax law while even mentioning Senator Moynihan by name, though no intermediary firm is mentioned, and failure to file a return was admitted.


Name of the Internal Revenue Code

Section 2(a) of the Act also officially changed the name of the
Internal Revenue Code The Internal Revenue Code (IRC), formally the Internal Revenue Code of 1986, is the domestic portion of federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 26 ...
from the ''Internal Revenue Code of 1954'' to the ''
Internal Revenue Code of 1986 The Internal Revenue Code (IRC), formally the Internal Revenue Code of 1986, is the domestic portion of federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 26 ...
''. Although the Act made numerous amendments to the 1954 Code, it was not a re-enactment or a substantial re-codification or reorganization of the overall structure of the 1954 Code. Thus, the tax laws since 1954 (including those after 1986) have taken the form of amendments to the 1954 Code, although it is now called the 1986 Code.


References


Works cited

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External links


Campaign 2000 Information Page
Citizens for Tax Justice Citizens for Tax Justice (CTJ) is a Washington, D.C.-based think tank and advocacy group founded in 1979 focusing on tax policies and their impact. CTJ's work focuses primarily on federal tax policy, but also analyzes state and local tax policie ...
"scorecard." *''Showdown at Gucci Gulch: Lawmakers,
Lobbyist In politics, lobbying, persuasion or interest representation is the act of lawfully attempting to influence the actions, policies, or decisions of government officials, most often legislators or members of regulatory agencies. Lobbying, which ...
s and the Unlikely Triumph of Tax Reform'' (1987), by
Jeffrey Birnbaum Jeffrey H. Birnbaum (born 1955) is an American journalist and television commentator. He previously worked for ''The Washington Post'' and ''The Washington Times''. He also regularly appears as a political analyst for the Fox News Channel and l ...
and Alan Murray, is a book about the bill's passage.
Full text of the Act
*Apps, P. F. (2010, June)
Why the Henry Review Fails on Family Tax Reform
In ''Australia’s Future Tax System: A Post-Henry Review'Conference, Sydney''. {{DEFAULTSORT:Tax Reform Act Of 1986 United States federal taxation legislation 1986 in law Presidency of Ronald Reagan 1986 in economics United States statutes that abrogate Supreme Court decisions