What is the Tax Reform Act of 1986?

Definition: The Tax Reform Act of 1986 is a tax law approved by Congress in 1986 that performed several changes to the previous tax legislation. It was intended to stimulate economic development within the country by relieving tax burdens from individuals.

What Does the Tax Reform Act of 1986 Mean?

This tax reform was pushed by Ronald Reagan’s administration and some congressmen to simplify a previously highly-complex tax system. This newly introduced reform reduced the income tax top rate from 50% to 28% and increased the bottom tax rate from 11% to 15%. It also simplified the way taxes were calculated, to avoid the exploitation of the previous more complex legislation. It eliminated tax shelters and loopholes that unfairly reduced the tax bill of many businesses and wealthy individuals.

On the other hand, owning a home became more attractive since the deduction on interest paid through mortgages was increased. Finally, among some other major changes, a new depreciation system was imposed to companies. It was called the Modified Accelerated Cost Recovery System (MACRS), and it established a useful life period for the various types of assets. Many other changes were made to previous tax laws through this reform, which was also known as the Second Reagan Tax Cut.

Example

If in 1986, after the reform was approved, a company buys a computer, the accounting department needs to set a depreciation schedule for it. According to MACRS, if a General Schedule is applied, a computer’s useful life period is 5 years.

If the computer was worth $600 the General Schedule states that the depreciation period starts six months after the purchase date. At this point, the depreciation rates are the following: Year 1 (6th to 12th month) = 20%, Year 2 = 32%, Year 3 = 19.20%, Year 4 = 11.52%, Year 5 = 11.52$ and Year 6 (1st to 6th month) = 5.76%. After this 5-year period has ended the computer should be fully depreciated.