25th Anniversary of the Tax Reform Act of 1986

It’s hard to believe that 25 years have passed since the U.S. Tax Code was overhauled (the anniversary for enactment is October 22). For those who long for the “good old days,” let’s take a walk down memory lane. You’ll see that some of the changes that were made have long since disappeared. Others became permanent features in the tax law.

Changes 25 years ago

The key to the Tax Code overall 25 years ago was supposed to be simplicity and the elimination of tax shelters that wealthy individuals used to avoid taxes. Here are key highlights of the changes under the 1986 Tax Code:

• Personal tax rates. They went from 15 tax brackets with a high of 50 percent, to two tax brackets—15 percent and 28 percent. This nearly “flat tax” of two rates lasted only from 1988 (1987 saw a phase-in of the new rates), or two years. In 1991, a third rate of 31 percent was introduced and in 1993, the top rate rose to 39.6 percent. Capital gains were taxed the same as ordinary income (the old 60 percent exclusion for capital gains was eliminated). However, when the ordinary rates rose in 1991, the rate on capital gains was kept at 28 percent; it remained there until 1997 when the rate on capital gains was dropped to 20 percent (10 percent for taxpayers in the lowest bracket).
• Corporate tax rates. They went from five brackets down to three brackets, with the maximum rate dropping to 34 percent (nearly the same as the 35 percent rate today).
• Research credit. This tax credit, which was introduced in 1981 and was set to expire, was extended for three years and reduced from 25 percent to 20 percent (the same as the current top credit amount).
• Depreciation. The accelerated cost recovery system was replaced by a modified accelerated cost recovery system (MACRS).
• Investment tax credit. This credit, which was created during the Kennedy administration, was repealed for most types of property.
• LIFO inventory. A simplified method of accounting for LIFO inventory was introduced.
• Tax shelters. Deductions in the absence of economic realties were limited by the introduction of the passive activity loss rules and the extension of the at-risk rules to real estate investments.

Proposed changes for the future

Today, politicians from both sides of the aisle are again saying that the Tax Code is too complex and what we need is simplicity. It will be interesting to see how “simplicity” is defined.