Title: The Dividends Received Deduction (DRD) — What It Is, How It Works, and Practical Steps to Claim It
Summary
The Dividends Received Deduction (DRD) is a U.S. corporate tax provision that lets a corporation deduct a specified portion of dividends it receives from other corporations. The primary policy goal is to reduce or eliminate “triple taxation” (tax once at the operating company level, again at an intermediate corporate shareholder, and again at the final shareholder). Eligibility and the deductible percentage depend mainly on ownership percentage, the source/type of the dividend, and a series of technical rules (holding period, related-party tests, taxable-income limitation, and statutory exclusions).
Key takeaways
– DRD reduces taxable income for corporations that receive dividends from other corporations.
– Percentage of deduction depends on ownership: typical post‑TCJA tiers are 50% (<20% ownership) and 65% (≥20% ownership but <80%); certain corporations and dividends may qualify for 100%.
– Important qualifiers: holding-period rules, taxable-income limitations, special exclusions (REIT and certain RIC dividends, tax-exempt payers), and different rules for foreign-source dividends (IRC §245A).
– Proper documentation and correct reporting on Form 1120 (Schedule C) are required.
1) Why the DRD exists
Without the DRD, the same corporate earnings could be taxed three times: at the operating corporation, at an intermediate corporate shareholder that receives a dividend, and at the ultimate corporate or individual shareholder. The DRD reduces the tax burden at the intermediate-corporate level and thus mitigates that layering of tax.
2) Who can claim the DRD
– Only C corporations (and other taxable corporations) generally claim the DRD. Pass‑through entities (S corporations, partnerships) do not claim a DRD on their owners’ tax returns in the same way.
– The corporation receiving the dividend must meet holding-period and other requirements (below) to qualify.
3) How much can be deducted (general tiers)
Post‑TCJA (tax years beginning after Dec. 31, 2017), common rules are:
– If the recipient owns less than 20% of the distributing corporation’s stock (by voting power and value), the general DRD is 50% of the dividend.
– If the recipient owns 20% or more (but less than 80%), the general DRD is 65%.
– Special 100% deductions may apply in limited situations (e.g., certain affiliated groups or where statutory provisions permit). Also, for certain foreign-source dividends, a 100% deduction under IRC §245A can apply to the foreign-source portion if statutory conditions (including a 10% ownership threshold and holding period) are satisfied.
Note: Ownership thresholds and percentages can depend on the specific IRC provisions that apply; check the statute and recent guidance for edge cases.
4) Primary qualification rules
– Holding period: The stock generally must be held for more than 45 days during the 91-day period that begins 45 days before the ex-dividend date. Special anti‑abuse or straddle rules can lengthen the required holding period for certain instruments (e.g., preferred stock with contingent dividends).
– Related-party adjustments: When the payer and recipient are related parties or part of an affiliated group, special rules may adjust the DRD or recharacterize transactions.
– Tax-exempt payers: If the distributing corporation was tax-exempt under IRC §501 (charities) or §521 (cooperatives) during the distribution year or the preceding year, the recipient cannot take a DRD for those dividends.
5) Exclusions and exceptions (typical)
– Dividends from REITs (real estate investment trusts) generally are not eligible for the corporate DRD.
– Capital gain dividends from regulated investment companies (RICs) are not eligible.
– Dividends from tax-exempt organizations are not deductible.
– Specialized industry exceptions (check IRC and Treasury regs).
6) Foreign dividends and IRC §245A (brief)
TCJA created (for many situations) a participation-exemption style rule under IRC §245A that allows a 100% deduction for the foreign-source portion of dividends received from certain 10%-owned foreign corporations, subject to a 365-day holding period and other limitations. This rule is complex and interacts with foreign tax credits and other international provisions — consult tax counsel for cross-border planning.
7) Taxable income limitation and NOL interactions
– The DRD is generally subject to a taxable-income limitation: the DRD cannot exceed a statutory percentage of the recipient corporation’s taxable income computed without regard to the DRD, certain NOL carrybacks, and a few other items.
– If a corporation has an NOL for the year, special rules apply and the taxable-income limitation on DRD may be handled differently (see IRS guidance and Form 1120 instructions for the exact ordering rules).
– Because these limits and sequencing rules are technical, compute tentative DRD, compute taxable-income limitation, and then apply ordered adjustments as required by Form 1120 instructions.
8) Practical step-by-step guide to claiming the DRD (checklist)
1. Identify the dividend received and document its nature:
– Source corporation (domestic vs. foreign)
– Payment date, ex-dividend date
– Amount and character (ordinary dividend vs. capital gain dividend)
2. Determine ownership percentage:
– Compute percentage by value and/or voting power as required.
– For foreign 245A claims, verify if you meet 10% ownership and other statutory conditions.
3. Verify holding-period compliance:
– Confirm stock was held more than 45 days during the 91-day window (or 365 days for certain foreign rules).
4. Confirm eligibility (exclude REIT capital gain dividends, RIC capital gains, dividends from tax-exempt entities, etc.).
5. Compute the tentative DRD:
– Tentative DRD = statutory percentage (50%/65%/100% as applicable) × dividend amount.
6. Apply the taxable-income limitation:
– Compute taxable income before DRD (and in some cases before NOLs per special rules), compare to statutory DRD limit (typically a percentage of that taxable income), and reduce DRD if necessary.
7. Consider NOL and carryback/forward interactions:
– If the corporation has an NOL, follow the ordering rules in Form 1120 instructions (the taxable-income limitation may be calculated without the 50%/65% cap in certain NOL cases).
8. Report on the tax return:
– Report dividend income and claim the DRD on Form 1120 (Schedule C and other applicable schedules) following Form 1120 instructions.
9. Maintain documentation:
– Stock purchase records, dividend notices, corporate ownership schedules, board minutes if relevant, and calculations supporting the deduction.
9) Simple numeric example
ABC Inc. owns 60% of DEF Inc. ABC has taxable income before DRD of $10,000 and receives a $9,000 dividend from DEF.
– Because ABC owns ≥20% but <80%, the applicable DRD percentage = 65%.
– Tentative DRD = 65% × $9,000 = $5,850.
– If the taxable-income limitation is not binding, ABC claims $5,850 DRD, reducing taxable income accordingly.
(Real filings must verify holding period and other eligibility rules before claiming.)
10) Recordkeeping and reporting tips
– Keep precise dates (ex-dividend date, purchase/sale dates) to document holding-period tests.
– Save dividend statements, broker confirmations, and board resolutions if applicable.
– Reconcile DRD calculations with financial statements and maintain a clear worksheet attached to tax filings for audit defensibility.
– Consider consulting a tax advisor for cross-border dividends or complex affiliated-group situations.
11) Common pitfalls
– Failing to meet the holding period (e.g., short-term trades around the ex-dividend date).
– Treating capital gain dividends from RICs or REIT dividends as eligible.
– Miscomputing ownership percentage when aggregates of share classes or indirect holdings exist.
– Overlooking the taxable-income limitation sequence or NOL interactions.
12) Where to read the authoritative guidance
– IRS Publication 542, Corporations (explains DRD basics and examples) — see IRS website.
– Internal Revenue Code sections: IRC §243 (partial DRD rules) and IRC §245A (participation exemption for certain foreign dividends).
– Form 1120 Instructions and Schedule C (reporting and computation details).
– For plain-language summaries, see Investopedia’s entry on the Dividends Received Deduction.
Sources
– Investopedia — “Dividends Received Deduction (DRD)” (source article provided)
– Internal Revenue Service — Publication 542, Corporations
– IRC §243 (dividends-received deduction rules) and IRC §245A (foreign-source dividend participation exemption)
– Form 1120 Instructions (Schedule C and related instructions)
If you’d like, I can:
– Produce a worked worksheet you can reuse (Excel-style steps) to compute DRD and apply the taxable-income limit, or
– Review a hypothetical set of facts (ownership percentages, dividend dates, taxable income, NOLs) and walk through the exact computation and required entries on Form 1120.