When it comes to your company’s tax planning and management, the dividends received deduction (DRD) can be a valuable tax deduction. The DRD allows a tax deduction when C corporations receive dividends from other corporations. This deduction is meant to help alleviate the consequences of triple taxation — while also reducing your company’s tax obligations.
In this article:
- A C corporation can take advantage of the dividends received deduction, reducing taxes owed on certain dividends received.
- Ownership level impacts the deduction percentage.
- There are certain limitations to the dividends received deduction.
How does the dividends received deduction alleviate triple taxation?
Triple taxation can be understood with the following scenario:
- First tax: The subsidiary corporation pays tax on income earned
- Second tax: The parent corporation pays tax on dividends received from the subsidiary corporation
- Third tax: Shareholders are taxed on the dividends they receive from the parent corporation
By allowing for a reduction in taxes paid by the parent corporation, the DRD helps alleviate this triple taxation scenario.
How does ownership level impact the dividends received deduction?
How much of the dividend can be deducted depends on ownership level of the payor’s stock:
- Less than 20% ownership: you can deduct up to 50% of the dividend received
- 20% to less than 80% ownership: you can deduct up to 65% of the dividend received
Let’s use an example to make the DRD concept easier to understand.
Company A owns 10% of Company B. Company A has a taxable income of $100,000 and a dividend of $10,000 from Company B. Because of its ownership percentage, Company A would be entitled to a DRD of $5,000 — 50% of the $10,000 dividend received.
What are the dividends received deduction limitations?
As explained by the IRS, dividends received from the following companies do not qualify for the DRD:
- A real estate investment trust (REIT).
- A corporation exempt from tax under section 501 or 521 of the Internal Revenue Code either for the tax year of the distribution or the preceding tax year.
- A corporation whose stock was held less than 46 days during the 91-day period beginning 45 days before the stock became ex-dividend with respect to the dividend. “Ex-dividend” means the holder has no rights to the dividend.
- A corporation whose dividends were received on any share of preferred stock that are attributable to periods totaling more than 366 days if such stock was held for less than 91 days during the 181-day period that began 90 days before the ex-dividend date.
- Any corporation, if your corporation is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property.
Income Limitations
There are additional income limitations to the amount you can deduct. The DRD cannot exceed the corporation’s taxable income. For example, to take a 50% deduction on a qualifying dividend, this deduction amount cannot exceed 50% of the corporation’s taxable income.
However, if a corporation has a net operating loss for the year, these income limitations do not apply.
Can you take the DRD on dividends from foreign corporations?
The IRS notes that “generally, 100% of the foreign-source portion of dividends from 10%-owned foreign corporations may be deducted.” But in order to qualify for this deduction, the corporation must respect the 365-day holding period of the foreign stock.
How do you calculate the dividends received deduction?
Calculate your DRD under Schedule C of Form 1120. To be sure you are accurately computing your C corporation’s DRD, work with a Landmark CPA.