The Dividends Received Deduction (DRD) is a tax break available to a C corporation (C-corp) that receives dividends from other corporations in which it is a shareholder. The DRD’s main purpose is to protect corporate income from being subject to multiple layers of 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.
Dividends Received Deduction Percentages
The percentage of DRD that a corporation will receive will depend on its 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% |
Holding Period Requirements
To be eligible for the DRD, the stock must generally be held by the payee corporation for a total of 46 days. That 46-day holding period must take place within a 90-day window, starting 45 days prior to the stock’s ex-dividendThe ex-dividend date is the date by which you must have already purchased the stock to be eligible for the dividend. If you buy the stock on the ex-dividend date, you will be ineligible for the immediately preceding dividend. date.
While this rule applies to both common and preferred stock, preferred stock that pays a dividend that has been accumulating for over 365 days has an extended holding period. This extended holding period is a total of 91 days of stock ownership that must take place within a 181-day window, starting 90 days prior to the stock’s ex-dividend date.
Taxable Income Limitation
In addition to the stock ownership limits and holding period requirements, DRD is limited to the percentage of taxable income. As shown in the table below, this means that if a corporation is allowed a 50% DRD based on stock ownership, that deduction can’t be more than 50% of taxable income.
| DRD Percentage (Based on Stock Ownership) | 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 |
For example, a company with less than 20% stock ownership would have a DRD of 50%, per the preceding table. If its taxable income for the year was $40,000, the DRD could not exceed $20,000 (50% of $40,000).
Computing the Taxable Income Limitation
To compute the taxable income limitation on DRD, a corporation’s taxable income is determined without regard for:
- NOL carryovers and carrybacks
- The DRD
- 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 figure of the calculation in Step 3 produces an NOL.
- If an NOL is created (or increased), then the product of Step 1 is your DRD.
- If an NOL is not created, 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 for domestic corporations. These scenarios assume that the corporation has met the applicable holding periods required for the deduction to be taken.
ABC Corp., a domestic football manufacturer, holds a 70% ownership stake in B.T.B Corp. In the current year, 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 × 65% = $162,500 tentative DRD
- Step 2: $300,000 × 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 × 65% = $19,500 tentative DRD
- Step 2: $25,000 × 65% = $16,250 taxable income limitation
- Step 3: $25,000 − $19,500 = $5,500
- Step 4: No NOL created, but 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 × 65% = $32,500 tentative DRD
- Step 2: $25,000 × 65% = $16,250 taxable income limitation
- Step 3: $25,000 − $32,500 = $7,500 NOL
- Step 4: Since an NOL is created, 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
- Certain foreign corporations
- Dividends received by a corporation that has not satisfied the holding period requirement
- 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
Common Pitfalls in Claiming DRD
When claiming the DRD, there are a few things to look out for.
Corporations may fail the holding period requirement for a few different reasons.
- Including the day of purchase in the holding period: When determining if you meet the required holding period, the day the stock is sold is included—but not the day of purchase is not.
- Wash sale holding periods are not included: When a wash sale loss is disallowed, the replacement stock’s holding period includes the original stock’s holding period. However, for DRD, only the period in which the replacement stock is actually owned counts toward the required holding period.
- Preferred stock requires a longer holding period: Preferred stock must meet a longer holding period of 91 days instead of the 46-day period applicable to common stock.
For the DRD to apply, the dividend must not be subject to attachment by a creditor. While preferred stock dividends may qualify for the DRD, the DRD may not apply when the preferred stock is defined in the corporate documents as having debt characteristics.
While most foreign dividends would not result in a DRD, there are exceptions to the rule. For dividends paid from foreign corporations with both domestic and foreign sources, the deduction is only allowed for the part of the dividends from US sources.
For more information on the DRD for foreign dividends, read the IRS’s Dividend Received Deduction Overview relating to foreign entities.
Frequently Asked Questions (FAQs)
The 70% percentage rate is no longer applicable for years after December 31, 2017. The current rates are 50%, 65%, or 100%.
No. This is a use-it-or-lose-it tax deduction. Any unused amounts aren’t carried forward to future years.
No. DRD is only available to domestic C-corps and is limited to the investor’s taxable income for the period.
Both common and preferred stock are eligible for the DRD.
The special 100% DRD is claimed by attaching a statement to the business’s income tax return stating that at the time of dividend receipt, the company was a “federal licensee” under the Small Business Investment Act of 1958.
Bottom Line
The DRD allows a domestic C-corp to deduct a portion of dividends received from another corporation in which it has an ownership interest. As a result, the corporation can reduce the tax it may have otherwise owed on dividends received.
