Ronald Reagan Tax Reform Act

The Tax Reform Act of 1986 constituted Ronald Reagan's second tax cut.

Tax legislation passed by the U.S. Congress under President Ronald Reagan includes the Tax Reform Act of 1986, also known as TRA 86. The law lowered the tax rates of both individuals and corporations and gave companies the opportunity to choose their own tax status. One required corporations to pay income taxes and the other passed the majority of tax responsibility to shareholders. The passage of TRA 86 constituted a shift in a segment of the overall tax burden, as unincorporated businesses changed their tax status.

History

Reagan administration tax legislation passed before TRA 86 included the Economic Recovery Tax Act of 1981 (ERTA), which reduced individual taxes and changed tax brackets. The primary vision of Reagan's tax initiatives called for a broadening of the tax base. The Tax Equity and Fiscal Responsibility Act of 1982 repealed certain provisions of ERTA that actually led to a narrowing of the tax base. TRA 86 constituted the second installment of tax cuts by the Reagan administration and became law in October 1986.

Objective

TRA 86 had two objectives: to expand the tax base and to lower tax rates for corporations and individuals. The theory behind the legislation estimated that lower taxation would lead to economic growth. Proponents also believed that lowering taxes would encourage compliance and reduce the gains associated with financial transactions used to evade payment of taxes.

Corporation Status Types

TRA 86 provided for two types of corporate tax statuses --- C corporations and S corporations --- and gave qualified corporations the option to choose their own status. The law required C corporations to pay income taxes on profits. S corporations were often not required to pay income taxes at a corporate level and could pass the tax liability to shareholders of the company.

Corporate Tax Rate Reduction

TRA 86 reduced the maximum tax rate for corporations by 12 percentage points, to 34 percent, and established only three tax brackets for companies. Corporate tax brackets started at 15 percent for companies with income of no more than $50,000. Corporations making $50,000 to $75,000 paid a tax rate of 25 percent, and companies with income exceeding $75,000 paid a 34 percent tax rate.

S Corporation Taxation

After the passage of TRA 86, companies in all types of industries changed their status to become S corporations. Eligibility for S corporation status depended on the type and number of shareholders and the number of stock classes; it did not permit foreign ownership of the corporation. Tax liability for S corporations fell primarily on the shareholder, who paid taxes defined by individual income rates.

Individual Tax Rate Reduction

TRA 86 reduced the individual tax rate from a maximum of 50 percent to 28 percent. Under a graduated transition, the highest tax bracket was lowered to 38.5 percent in 1987 and to 28 percent in 1988. While reducing tax rates for the highest income earners, tax rates for the lowest income earners rose from 11 percent to 15 percent by 1988.

References

• Internal Revenue Service: S Corporation Elections After the Tax Reform Act of 1986
• National Tax Journal: Tax Reform Act of 1986
• Pearson: The Tax Reform Act of 1986
• Internal Revenue Service: S Corporations
• Internal Revenue Service: Corporations
• Tax Foundation: Federal Individual Income Tax Rates History