Tax Reform Act of 1976

The Tax Reform Act was designed to eliminate tax abuses and provides more tax payer rights.

The U.S. Tax Reform Act of 1976 eliminated tax abuses and made the tax system more fair to tax payers of all income levels, according to the "General Explanation of the Tax Reform Act of 1976" by the Joint Committee on Taxation. The act, which was signed into law Oct. 4, 1976, addresses capital gains, high incomes, foreign incomes and pensions.

Impacts on High-Income Individuals and Corporations

To reduce the likelihood by high-income individuals and corporations of avoiding paying the apporpriate amount of taxes, the act increased the minimum amount on tax-preferred income from 10 percent to 15 percent. The act also added a tax preference for intangible oil drilling costs and for itemized deductions in excess of 60 percent of a taxpayer's total income before taxes.

Tax preferences are items added back into the taxpayer's total income, creating a higher amount that is subject to taxes.

In addition, the act extended a 50-percent maximum marginal tax rate from personal services only to also include deferred compensations such as investments like pensions and annuities.

A marginal tax rate is the tax rate on the last dollar of income earned.

Capital Gains

The act contained measures to curb tax sheltering, which is a method taxpayers use to decrease their taxable income. One of those measures was expanding the recapture rule to prevent taxpayers from converting ordinary income into a capital gain when investing in real estate, farm syndicates, motion picture production companies, oil drilling and sports franchises. A capital gain is a profit an investor makes when selling capital assets such as investments or real estate. The recapture rule allows the Internal Revenue Service to collect any income gain a taxpayer earns from the disposal of an asset as ordinary income.

Foreign Income

Most tax-related incentives for investing outside the U.S. were eliminated in the act except for the foreign income tax deferral. A deferral is given to a taxpayer who earns income abroad until they return to the U.S. The pre-country limitation on the foreign tax credit was also repealed, meaning that a company can no longer deduct a loss in a foreign country against U.S. income to avoid paying a tax on the profit through the foreign tax credit.

IRAs

The act expanded a provision for individual retirement accounts, better known as IRAs, to allow a working spouse to set up an IRA for a nonworking spouse. The act created a $1,750 per month contribution limit if both spouses set up an IRA, but the contributions can be made to a single account with a sub account or two separate accounts.

References

• Alvin Brown & Associates: "General Explanation of the Tax Reform Act of 1976," Dec. 29, 1976
• The Joint Committee on Taxation Congress of the United States: Tax Legislation Enacted In the 94th Congress