Tax Reform Act of 1986

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Tax Reform Act of 1986 — Overview

The Tax Reform Act of 1986 was a major overhaul of the U.S. federal income tax system enacted to simplify the tax code, broaden the tax base, and lower marginal tax rates. Signed into law by President Ronald Reagan on October 22, 1986, the law sought to reduce tax shelters and create a fairer tax structure that encouraged economic growth.

Key takeaways

  • Dramatically lowered top individual and corporate tax rates while broadening the tax base.
  • Reduced opportunities for tax shelters by limiting deductions and tightening rules.
  • Tax treatment of long-term capital gains was aligned with ordinary income rates.
  • Set the stage for later tax changes, notably in 1993.

Main provisions

Individual income tax rates

  • Top marginal individual income tax rate fell from 50% to 28%.
  • The lowest ordinary income rate rose from 11% to 15%, narrowing the number of tax brackets and compressing rates.

Capital gains

  • The special, lower treatment for many long-term capital gains was largely eliminated: long-term capital gains were taxed at the same rates as ordinary income, raising the maximum capital-gains rate (from 20% to as high as 28%).
  • Prior to reform, a 60% exclusion applied to many capital gains, producing a substantially lower effective rate; the 1986 changes removed much of that preferential treatment.

Base broadening and deduction limits

  • Many tax shelters and preferential deductions were curtailed or eliminated.
  • Deductions for certain business expenses (meals, travel, entertainment) were limited.
  • Deductibility of interest on consumer loans was ended.
  • Personal exemptions and the standard deduction were increased and indexed to inflation.
  • Tax filers claiming dependents were required to provide Social Security numbers to claim dependent-related tax benefits.

Alternative Minimum Tax (AMT)

  • The AMT was expanded to ensure higher-income taxpayers could not fully escape tax liability through exclusions, credits, and deductions.

Homeownership incentives

  • The mortgage interest deduction was preserved and increased to continue encouraging homeownership, even as other deductions were narrowed.

Corporate taxes

  • The top corporate tax rate was reduced from 50% to 35%.
  • At the same time, allowances for certain business deductions were tightened and depreciation rules adjusted to offset revenue losses from lower rates.

Goals and impact

The Act aimed to make the tax system simpler and fairer by lowering statutory rates while eliminating many deductions and preferences that allowed high-income taxpayers to reduce their taxable income. By broadening the base, the law maintained (and in some cases increased) tax revenue neutrality despite lower marginal rates. It also reduced opportunities for aggressive tax avoidance.

The reform reshaped tax policy debates and influenced subsequent reforms. Some provisions—most notably the change in capital-gains treatment and the expanded AMT—had complex, lasting effects on taxpayers and tax planning.

Subsequent developments

Significant follow-up changes came in the early 1990s. The Revenue Reconciliation Act of 1993 (often cited as the 1993 tax changes) reintroduced higher rates for certain taxpayers and made other adjustments to individual and corporate taxation, reversing or modifying parts of the 1986 framework.

Further reading

  • Congress.gov — H.R.3838, Tax Reform Act of 1986
  • Tax Foundation — analysis of 1980s tax reforms
  • Encyclopedia Britannica — Tax Reform Act of 1986