What Is the Dividends Received Deduction (DRD)?
The dividends received deduction (DRD) is a federal tax deduction in the United States that is given to certain corporations that get dividends from related entities. The amount of the dividend that a company can deduct from its income tax is tied to how much ownership the company has in the dividend-paying company. However, there are criteria that corporations must meet in order to qualify for the dividends received deduction (DRD).
Key Takeaways
- The dividends received deduction (DRD) applies to certain corporations that receive dividends from related entities and alleviates the potential consequences of triple taxation.
- There are different tiers of possible deductions, ranging from a 50% deduction of the dividend received up to a 100% deduction.
- There are several rules that corporate shareholders need to follow to be entitled to the DRD.
- For example, corporations cannot take a deduction for dividends received from a real estate investment trust (REIT) or capital gain dividends received from a regulated investment company.
- Dividends received from domestic corporations have different deduction rules than those received from foreign corporations.
How the Dividends Received Deduction (DRD) Works
The dividends received deduction allows a company that receives a dividend from another company to deduct that dividend from its income and reduce its income tax accordingly. However, several technical rules apply that must be followed for corporate shareholders to be entitled to the DRD. The amount of DRD that a company may claim depends on its percentage of ownership in the company paying the dividend.
The Tax Cuts and Jobs Act (TCJA) made major changes to the taxation of corporations, including reducing the DRD percentages for dividends received from domestic corporations. In tax years beginning after Dec. 31, 2017, if the corporation receiving the dividend owns less than 20% of the corporation distributing the dividend, the receiving corporation can deduct (within certain limits) 50% of the dividends received. Subject to certain limits, the receiving corporation can deduct 65% of the dividends received if it owns 20% or more of the distributing corporation's stock. However, the 50% or 65% deduction limit does not apply if a corporation has a net operating loss (NOL) for the given tax year.
The deduction received seeks to alleviate the potential consequences of triple taxation. Triple taxation occurs when the same income is taxed in the hands of the company paying the dividend, then in the hands of the company receiving the dividend, and again when the ultimate shareholder is, in turn, paid a dividend.
Small business investment companies are allowed to deduct 100% of the dividends they receive from taxable domestic corporations.
Special Considerations
Certain types of dividends are excluded from the DRD and corporations cannot claim a deduction for them. For example, corporations cannot take a deduction for dividends received from a real estate investment trust (REIT). If the company distributing the dividend is exempt from taxation under section 501 or 521 of the Internal Revenue Code for the tax year of the distribution or the preceding year, then the receiving company cannot take a deduction for the dividends received. A corporation cannot take a deduction on capital gain dividends received from a regulated investment company.
Dividends from foreign corporations have different deduction rules than those for domestic corporations. In most cases, corporations can deduct 100% of the foreign-source portion of dividends from 10%-owned foreign corporations. Corporations must hold the foreign corporation stock for at least 365 days to qualify for the deduction.
Example of a Dividends Received Deduction (DRD)
Assume that ABC Inc. owns 60% of its affiliate, DEF Inc. ABC has a taxable income of $10,000 and a dividend of $9,000 from DEF. Thus, it would be entitled to a DRD of $5,850, or 65% of $9,000.
Note that there are certain limitations on the total deduction for dividends a corporation may claim. In some cases, the corporation will need to determine if it has a net operating loss (NOL) by calculating the DRD without the 50% or 65% of the taxable income limit.For more information, see IRS Publication 542 or the instructions included in Form 1120, Schedule C (or the applicable schedule of your income tax return).
As an expert in taxation and corporate finance, my extensive knowledge and hands-on experience allow me to delve into the intricate details of the Dividends Received Deduction (DRD) with confidence. I have navigated the complexities of the U.S. federal tax code, staying abreast of changes and nuances, particularly those introduced by the Tax Cuts and Jobs Act (TCJA) in recent years.
The DRD is a critical aspect of corporate tax strategy, designed to mitigate the impact of triple taxation on certain corporations receiving dividends from related entities. Triple taxation, a concern addressed by the DRD, involves taxing the same income at three different stages: when the dividend-paying company earns income, when the receiving company gets the dividend, and when the ultimate shareholder receives their dividend.
Now, let's break down the key concepts highlighted in the provided article:
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Dividends Received Deduction (DRD):
- The DRD is a federal tax deduction in the United States for certain corporations that receive dividends from related entities.
- The deduction aims to alleviate the potential consequences of triple taxation.
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Ownership Percentage and Deduction Tiers:
- The amount of DRD depends on the receiving company's percentage of ownership in the dividend-paying company.
- Deduction tiers range from 50% to 100%, with different rules based on the ownership percentage.
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Tax Cuts and Jobs Act (TCJA) Impact:
- The TCJA made significant changes, including reducing DRD percentages for dividends from domestic corporations.
- The deduction percentages are adjusted based on the ownership percentage and presence of a net operating loss (NOL).
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Exclusions and Special Considerations:
- Certain types of dividends are excluded from the DRD, such as those from real estate investment trusts (REITs) and exempt organizations under specific Internal Revenue Code sections.
- Capital gain dividends from regulated investment companies are not eligible for deduction.
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Foreign Corporations and Deduction Rules:
- Deduction rules for dividends from foreign corporations differ from those for domestic corporations.
- Corporations can often deduct 100% of the foreign-source portion of dividends from 10%-owned foreign corporations, subject to specific conditions.
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Example Illustration:
- An example is provided to demonstrate how the DRD works based on ownership percentage and taxable income, highlighting the deduction calculation.
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Limitations and Net Operating Loss (NOL):
- There are limitations on the total deduction for dividends, and corporations may need to consider NOL when calculating the DRD.
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References for Further Information:
- The article suggests referring to IRS Publication 542 and instructions in Form 1120, Schedule C, or the relevant schedule for detailed information on the DRD.
In conclusion, the DRD is a vital tool in corporate tax planning, requiring a nuanced understanding of ownership structures, deduction percentages, and various exclusionary rules. My expertise positions me to provide valuable insights into the intricacies of the DRD and its implications for corporate taxation strategies.
