Tax Reform Act of 1986

The Tax Reform Act (TRA) of 1986 was the most extensive review and overhaul of the Internal Revenue Code by the U.S. Congress since the inception of the income tax in 1913 (the Sixteenth Amendment). The purpose of the TRA was to simplify the tax code, broaden the tax base, and eliminate many tax shelters and preferences. The TRA was intended to be essentially revenue-neutral though it did shift some of the tax burden from individuals to businesses. Although often described as one of President Ronald Reagan's (a Republican) greatest legislative legacies, the TRA was officially sponsored by two leading Democrats, Representative Richard Gephardt of Missouri and Senator Bill Bradley of New Jersey, and was strongly supported by the House Ways and Means chairman, Representative Dan Rostenkowski of Illinois (a Democrat). The legislation was signed into law on October 22, 1986.

The TRA reduced the number of individual income tax brackets from 14 to 2. The TRA also lowered the top tax rate for individuals from 50% to 28% and raised the bottom rate from 11% to 15%. The TRA removed millions of low-income citizens from the income tax rolls. The TRA ended tax code provisions for individuals to deduct interest on consumer loans; however, it increased personal exemptions and standard deduction amounts and indexed them to inflation. The TRA revised tax credits for amounts that individuals could contribute to certain types of individual retirement accounts (IRAs). The TRA strengthened the “alternative minimum tax” provisions of the income tax code for individuals, which were first created in 1978. The TRA passive loss limitation provisions reduced the use of certain tax shelters by wealthy individuals.

The corporate tax rate was reduced from 50% to 35%. The TRA repealed corporate tax preferences for the investment tax credit for the purchase of depreciable assets, lengthened certain asset lives for cost recovery, and limited bank deductions for loan-loss reserves in a given year. It also reduced the allowances for certain business expenses, such as business meals, travel, and entertainment, and restricted deductions for certain other expenses. One provision of the TRA created an alternative minimum tax for corporations (at a rate of 20%) to replace an existing corporate add-on minimum tax.

Since the passage of the TRA in 1986, tax code revision has become virtually a perennial event, resulting in the return of many tax breaks and an increase in the number of tax brackets. Of particular note were the Revenue Reconciliation Act of 1990 under President George H. W. Bush, the Revenue Reconciliation Acts of 1993 and 1997 under President Bill Clinton, and the Economic Growth and Tax Relief Act and Reconciliation Act of 2001 under President George W. Bush.