PL 94-455: Key Provisions of the Tax Reform Act

Public Law 94-455, the Tax Reform Act of 1976, was a substantial revision of the Internal Revenue Code. In the mid-1970s, low public trust in government following the Watergate scandal fueled demand for tax changes. There was a growing perception that the system was unfair, with loopholes allowing high-income individuals and corporations to pay little in taxes, shifting the burden to the middle class.

This sentiment pressured Congress to address structural issues, enhance fairness, and close the loopholes that had eroded the tax base. Signed into law on October 4, 1976, the Act aimed to restore public confidence by making the tax system more equitable. The reforms were comprehensive, seeking to curb tax shelters, simplify individual taxation, and restructure the taxation of businesses and wealth transfers.

Major Reforms to Individual Taxation

A central feature of the Tax Reform Act of 1976 was the introduction of a stronger minimum tax for individuals. This was a direct response to high-income taxpayers who could legally eliminate their federal tax liability by combining various deductions and exclusions. The Act strengthened the existing minimum tax rules by increasing the rate and reducing applicable exemptions.

This change functioned as a parallel tax calculation, ensuring individuals with high economic income could not completely escape taxation through preferential deductions. This system was a precursor to the modern Alternative Minimum Tax (AMT).

The Act also introduced changes aimed at simplifying the tax filing process. The standard deduction, which a taxpayer can claim without itemizing expenses, was converted to a flat amount. For 2025, the standard deduction is set at $15,000 for single individuals and $30,000 for married couples filing jointly. This change simplified tax preparation for millions of Americans.

Furthermore, the law expanded the Earned Income Tax Credit (EITC). The EITC was designed to supplement the wages of low-income workers, particularly those with children, and to offset the burden of Social Security taxes. The 1976 Act made the credit more generous and accessible, reinforcing its role as an anti-poverty tool.

Changes to Business and Investment Taxation

The Act brought significant adjustments to business and investment taxation, with a focus on capital gains. It extended the holding period required for an asset to qualify for long-term capital gains treatment from six months to one year. This change made it more difficult for investors to receive preferential tax treatment on profits from assets like stocks, with the rationale being to distinguish between short-term trading and long-term investment. This one-year holding period remains the standard today.

The law also modified the corporate tax rate structure, adjusting lower-tier rates to provide tax relief to smaller businesses. This tiered structure was later replaced by a flat 21% federal corporate tax rate.

Additionally, the law addressed the Investment Tax Credit (ITC), which allowed businesses to reduce their tax liability based on the cost of new equipment. The Act extended a temporary increase in the ITC to stimulate business spending, though this general credit was largely repealed in 1986.

Introduction of At-Risk Rules for Tax Shelters

A major target of the Act was the proliferation of tax shelters that generated large, artificial losses for investors. A common strategy involved nonrecourse financing, where a business would acquire an asset financed by debt for which investors had no personal liability. Despite the lack of personal risk, the law allowed investors to include this nonrecourse debt in their investment’s tax basis.

This inflated basis was used to calculate deductions, creating paper losses that often exceeded an investor’s actual cash contribution. These losses could then be used to shelter income from other sources, significantly reducing the investor’s overall tax bill.

The 1976 Act introduced the “at-risk” rules to combat this practice by limiting an investor’s deductible losses to the amount they had personally at risk. The amount at risk was defined as the taxpayer’s direct cash investment plus any borrowed amounts for which they were personally liable.

For example, if an investor put $10,000 of cash into a partnership that took out a $90,000 nonrecourse loan, the investor’s deductible losses would be capped at their $10,000 at-risk amount. These at-risk rules remain a fundamental part of the tax code today, serving as a backstop against artificial loss deductions.

Unification of Estate and Gift Taxes

Prior to 1976, the systems for taxing wealth transfers during life (gifts) and at death (estates) were separate. Each system had its own tax rates and exemptions, and the rates for lifetime gifts were significantly lower than those for estates. This created a tax incentive for wealthy individuals to transfer a large portion of their assets to heirs through gifts while they were still alive.

This dual structure allowed for planning strategies that could dramatically reduce the total tax paid on the transfer of a family’s wealth. Assets given away during life were taxed more favorably than if they had been held until death.

The 1976 Act restructured this area by combining the estate and gift taxes into a single, unified transfer tax. The law created one progressive tax rate schedule that applied to the cumulative total of taxable transfers made during life and at death. This meant lifetime gifts would push the taxable estate into a higher tax bracket.

To complement this, the Act introduced the unified credit, a single credit that could be applied against either gift or estate tax liability. While this unified system remains the basis for current law, the credit and its corresponding exemption amount are subject to legislative adjustments, including a substantial reduction scheduled for the end of 2025.

Administrative and Procedural Provisions

The Act also introduced important administrative reforms, with a focus on regulating paid tax return preparers. It established new standards of conduct and accountability for anyone who prepared federal tax returns for compensation. Today, all paid preparers must obtain a Preparer Tax Identification Number (PTIN) from the IRS, but there are no universal competency standards.

The 1976 rules required tax preparers to sign the returns they completed and provide their identifying number. The law also imposed penalties on preparers for the negligent or intentional disregard of tax rules and for any willful understatement of a client’s tax liability. These provisions were designed to professionalize the industry and protect taxpayers.

The Act also contained provisions to strengthen taxpayer privacy. It established stricter rules regarding the disclosure of tax return information by the IRS, codifying the principle that tax returns are confidential and cannot be disclosed except in specific, legally defined circumstances. These foundational privacy principles remain a key component of the U.S. tax system.

This section of the Act also imposed new procedural requirements on the IRS when it sought taxpayer records from third parties, such as banks. It established rules for issuing administrative summonses, giving taxpayers notice and the right to challenge the summons in court. These changes were a reaction to concerns about potential government overreach and aimed to safeguard citizens’ privacy rights.