Why Dividends Received Deduction is important?
Dividends Received Deduction (DRD) is available to Corporations. The purpose of the dividends received deduction is to mitigate multiple taxation of corporate income. If a corporation owns a stock in another corporation and receives dividends, then a portion of dividends may be deducted from income as a special deduction which is called Dividends Received Deductions (DRD).
An example of DRD
A Dividend Paying Corporation issues $10,000 dividends to the Dividend Receiving Corporation.
On the form of 1120, there is $10,000 Dividend Income but potentially the Dividend Receiving Corporation can claim deductions.
| Percentage of Ownership by Corporate Shareholder | Deduction Percentage |
|---|---|
| < 20% | 50% |
| >=20% but < 80% | 65% |
| >=80% and affiliated | 100% |
DRD is subjected to Modified Taxable Income limitation. For this purpose, the taxable income is computed without regard:
- The NOL
- The Dividends Received Deduction
- Any capital loss carryback to the current tax year
The following steps are used in applying the calculations for DRD
- Multiply the dividends received by the deduction percentage
- Multiply the taxable income (calculated above) by the deduction percentage
- Limit the deduction to the lesser of step 1 or step 2. If deducting the amount in step 1 results in an NOL, the amount in step 1 is used (NOL rule)
Calculation
| X Corporations | Y Corporations | Z Corporations | |
|---|---|---|---|
| Gross Income from operations | $600,000 | $480,000 | $320,000 |
| Expenses from operations | ($490,000) | ($490,000) | ($490,000) |
| Dividends received from domestic corporations (< 20% Ownership | $300,000 | $300,000 | $300,000 |
| Taxable Income before DRD | $410,000 | $290,000 | $130,000 |
| Three-step procedure for DRD | |||
| Step 1: (50% x $300,000) | $150,000 | $150,000 | $150,000 |
| Step 2 | |||
| 50% x $410,000 | $210,000 | ||
| 50% x $290,000 | $145,000 | ||
| 50% x $130,000 | $65,000 | ||
| Step 3 | |||
| Lesser of Step 1 or Step 2 | $150,000 | $145,000 | $150,000 (*) |
In the example, DRD for X and Y Corporations are straight forward which is $150,000 for X Corporation and $145,000 for Y Corporation.
(*) Z Corporation qualifies for NOL rule treatment because subtracting $150,000 (step 1) from $130,000 taxable income before DRD results a negative number. So Z Corporation can deduct $150,000,
Important Notes
Some important notes in order to qualify for DRD
- Hold stock for 45 days under most situations (IRC section 246(c))
- The standard rate of deduction (50%, 65% an 100% for 2018) applies for domestic corporations
For planning purposes, Corporations should consider the timing of income and deductions to qualify NOL rule. This rule may result in a significant amount of a corporation’s DRD.
Khanh Le, preferred name as Jessica Le, is a licensed Certified Public Accountant (CPA). Jessica also earned a Master of Business Administration (MBA) from San Jose State University.
