The Dividends Received Deduction (DRD) is a tax break available to domestic C corporations (C-corps) that own stock in other domestic corporations and receive dividends from them. The DRD’s main purpose is to protect corporations from being subject to triple taxation.
A corporation can claim a specific amount of DRD based on its ownership stake in the company that pays the dividend and the taxable revenue of the receiving corporation. The deduction is claimed on Schedule C of IRS Form 1120.
Triple-taxation occurs when income is earned by a subsidiary corp (first tax paid) is then paid as a dividend to the parent corp (second tax paid), who then pays it as another dividend to the owner (third tax paid). DRD reduces the tax paid on dividends received by parent corp, thereby at least partially eliminating the triple taxation.
Dividends Received Deduction Percentages
The percentage of DRD that a corporation will receive will depend on their ownership percentage in the dividend-paying corporation:
Percentage of Stock Ownership | Dividends Received Deduction Percentage |
|---|---|
Less than 20% | 50% |
20% to less than 80% | 65% |
80% or more or a small business investment company | 100% |
Taxable Income Limitation
In addition to the stock ownership limits, DRD is also limited to the percentage of taxable income.
DRD Percentage | Taxable Income Limitation |
|---|---|
50% | DRD cannot exceed 50% of the corporation’s taxable income |
65% | DRD cannot exceed 65% of the corporation’s taxable income |
100% | No limit; full amount of the deduction can be claimed |
The taxable income limit doesn’t apply if the corporation has a net operating loss (NOL) for the current tax year.
Computing the Taxable Income Limitation
For the purpose of computing the taxable income limitation on DRD, a corporation’s taxable income is determined without regard for:
- NOL carryovers and carrybacks
- The DRD
- The domestic production activities deduction (DPAD)
- The deduction for dividends paid on certain preferred stock of public utilities
- Certain adjustments for extraordinary dividends
- Capital loss carrybacks
How To Calculate the Dividends Received Deduction
- Step 1: Multiply the dividend received by the appropriate DRD percentage.
- Step 2: Multiply your taxable income by the appropriate DRD percentage.
- Step 3: Deduct the product of Step 1 from your taxable income.
- Step 4: Determine whether the sum of the calculation in Step 3 produces a NOL.
- If NOL is created (or increased), then the product of Step 1 is DRD.
- If the sum doesn’t create NOL, then the deduction is limited to the lesser of Step 1 or Step 2.
Let’s take a look at examples to better understand the DRD computation.
ABC Corp. is a domestic football manufacturer. ABC holds a 70% ownership stake in B.T.B Corp. In 2022, the following applied to ABC Corp.:
- Gross income: $500,000
- Expenses: $200,000
- Taxable income before DRD: $300,000
- Dividends received from B.T.B Corp.: $250,000
The DRD for ABC Corp. will be calculated as follows:
- Step 1: $250,000 x 65% = $162,500 tentative DRD
- Step 2: $300,000 x 65% = $195,000 taxable income limitation
- Step 3: $300,000 – 162,500= $137,500
- Step 4: No NOL created. DRD is $162,500.
123 Corporation owns 70% of Small Corporation and has the following income and expense for the year:
- Gross income: $300,000
- Expenses: $275,000
- Taxable income before DRD: $25,000
- Dividends received from Small Corporation: $30,000
The DRD for 123 Corporation will be calculated as follows:
- Step 1: $30,000 x 65% = $19,500 tentative DRD
- Step 2: $25,000 x 65% = $16,250 taxable income limitation
- Step 3: 25,000 – $19,500= $5,500
- Step 4: No NOL created and the taxable income limitation is less than the tentative deduction so the DRD is $16,250.
X Corporation owns 70% of Y Corporation and has the following income and expense for the year:
- Gross Income: $250,000
- Expenses: $225,000
- Taxable income before DRD: $25,000
- Dividends received from Y Corporation: $50,000
The DRD for X Corporation will be calculated as follows:
- Step 1: $50,000 x 65% = $32,500 tentative DRD
- Step 2: $25,000x 65% = $16,250 taxable income limitation
- Step 3: $25,000 – $32,500 = $7,500 NOL
- Step 4: NOL created, so the taxable income limitation doesn’t apply, and the DRD is $32,500.
Dividend Types Excluded From the DRD
A corporation cannot claim a deduction for dividends received from any one of the following:
- Real estate investment trust (REIT)
- Capital gain distribution from regulated investment companies (RICs).
- Mutual savings banks
- Tax-exempt corporations
- Certain public utilities on preferred stock
- Farmers’ cooperative associations
- Certain dividends from federal home loan banks
- Dividends purchased with borrowed money
- Certain foreign corporations
- A corporation whose stock was held less than 46 days during the 91-day period beginning 45 days before the stock became an ex-dividend with respect to the dividend.
- A corporation whose preferred stock was held for less than 91 days during the 181-day period beginning 90 days before the stock became an ex-dividend with respect to the dividend if the dividends received are for a period totaling more than 366 days
- Any corporation that’s under an obligation―short sale or otherwise―to make related payments with respect to positions in substantially similar or related property
Frequently Asked Questions (FAQs)
When is the percentage rate for the dividend received deduction of 70%?
The 70% percentage rate is no longer applicable for years after Dec. 31, 2017. The current rates are 50%, 65%, or 100%.
Can dividend received deduction be carried forward to future tax years?
No. This is a use-it-or-lose-it tax deduction. Any unused amounts aren’t carried forward to future years.
Can S-corporations take advantage of the dividends received deduction?
No. DRD is only available to domestic C-corps and is limited to the investor’s taxable income for the period.
Bottom Line
The DRD allows domestic corporations to deduct a portion of dividends received from another domestic corporation for which they have an ownership interest. As a result, corporations can avoid at least a portion of the tax they would otherwise owe on dividends received.
