Connect with us

Taxes

What Is the Dividends Received Deduction & How to Compute

Published

on

XYZ Corp., a domestic software development company, holds a 15% ownership stake in Tech Innovations Inc. In the current year, the following applied to XYZ Corp.:

  • Gross income: $400,000
  • Expenses: $150,000
  • Taxable income before DRD: $250,000
  • Dividends received from Tech Innovations Inc.: $100,000

The DRD for XYZ Corp. will be calculated as follows:

  • Step 1: $100,000 × 50% = $50,000 tentative DRD
  • Step 2: $250,000 × 50% = $125,000 taxable income limitation
  • Step 3: $250,000 − $50,000 = $200,000
  • Step 4: No NOL created. DRD is limited to $50,000.


By understanding the Dividends Received Deduction and how it is calculated, C corporations can take advantage of this tax break to reduce the impact of multiple layers of taxation on their corporate income. It is essential for corporations to comply with the ownership percentage, holding period, and taxable income limitation requirements to maximize the benefits of the DRD.

123 Corporation owns 70% of Small Corporation and has the following income and expenses 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.

  1. 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.
  2. 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.

A wash sale is one in which the taxpayer sells stock at a loss but purchases identical stock within 30 days before or after the sale.

  1. 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.

Understanding the Dividend Received Deduction for Foreign Corporations

When it comes to dividends paid from foreign corporations with both domestic and foreign sources, the deduction is only allowed for the portion of the dividends from US sources. This means that only the part of the dividends originating from US sources is eligible for the deduction.

For further insights on the Dividend Received Deduction (DRD) for foreign dividends, it is advisable to refer to the IRS’s Dividend Received Deduction Overview specifically related to foreign entities. This resource can provide comprehensive information and guidelines regarding the deduction for foreign dividends.

Frequently Asked Questions (FAQs)

When is the percentage rate 70% for the dividend received deduction?

The 70% percentage rate is no longer applicable for tax years after December 31, 2017. The current deduction rates for the dividend received deduction are set at 50%, 65%, or 100% based on specific criteria.

Can the dividend received deduction be carried forward to future tax years?

No, the dividend received deduction cannot be carried forward to future tax years. It is a “use-it-or-lose-it” tax deduction, meaning any unused amounts cannot be utilized in subsequent tax periods.

Can S-corps take advantage of the dividends received deduction?

No, the Dividend Received Deduction (DRD) is exclusively available to domestic C-corps. S-corps are not eligible for this deduction, and the deduction amount is limited to the taxable income of the investor for the relevant period.

What types of dividends are eligible for the dividends received deduction?

Both common and preferred stock dividends are eligible for the Dividend Received Deduction. This deduction can be applied to dividends received from various types of stock investments.

How does a small business investment company claim the 100% dividends received deduction?

A small business investment company can claim the special 100% Dividend Received Deduction by including a statement with its income tax return. This statement should indicate that at the time of receiving the dividends, the company was a “federal licensee” under the Small Business Investment Act of 1958.

Bottom Line

The Dividend Received Deduction (DRD) offers domestic C-corps the opportunity to deduct a portion of dividends received from other corporations in which they hold ownership interests. This deduction enables corporations to reduce their tax liability on dividends received, providing a valuable tax-saving benefit.

See also  The Best Tax Preparation Services for your Business
Continue Reading
Click to comment

Leave a Reply

Your email address will not be published. Required fields are marked *

Personal Growth

Trending