DETERMINATION OF THE EFFECTS OF THE TAX REFORM ACT OF 1986 ON THE INCOME TAXES OF INDIVIDUAL PASSIVE ACTIVITY INVESTORS

When new tax laws are considered, one of the many concerns is how the changes will affect individual taxpayer's tax liability. One goal of the Tax Reform Act of 1986 was to eliminate abusive tax sheltering schemes. The area of tax law most dramatically changed by the TRA'86 was passive activity taxation. The objective of the research was to determine what effect the TRA'86 had on individual passive activity investors' tax liabilities. Four important changes in the TRA'86 were included in the research: (1) the elimination of the deduction for passive activity losses against ordinary income, (2) the increase in the alternative minimum tax rate with changes in AMT preferences, (3) the elimination of the 60% capital gains deduction, and (4) the decrease in federal income tax rates.; The major results of the effects of the tax changes were: (1) the disallowance of the reduction of ordinary income with passive activity losses caused a significant increase in the tax liabilities, (2) the alternative minimum tax law changes caused a significant decrease in the tax debts, (3) the elimination of the 60% capital gains deduction caused the tax liabilities to be significantly higher after TRA'86, and (4) the lowering of the income tax rates caused a significant decrease in tax liabilities. When all four studied tax changes were analyzed in combination, the research results indicate that the tax liabilities of passive activity investors changed very little as a result of TRA'86. The overall results indicate that the TRA'86 was indeed revenue neutral and that the majority of passive activity investors realized little if any change in tax liabilities as a result of the tax reform.