Dividends Received Deduction – DRD (IRC section 243)
Why Dividends Received Deduction is important?
Dividends Received Deduction (DRD) is available to Corporations. The purpose of the dividends received deduction is to mitigate multiple taxation of corporate income. If a corporation owns a stock in another corporation and receives dividends, then a portion of dividends may be deducted from income as a special deduction which is called Dividends Received Deductions (DRD).
An example of DRD
A Dividend Paying Corporation issues $10,000 dividends to the Dividend Receiving Corporation.
On the form of 1120, there is $10,000 Dividend Income but potentially the Dividend Receiving Corporation can claim deductions.
Percentage of Ownership by Corporate Shareholder Deduction Percentage < 20% 50% >=20% but < 80% 65% >=80% and affiliated 100%
DRD is subjected to Modified Taxable Income limitation. For this purpose, the taxable income is computed without regard:
The NOL
The Dividends Received Deduction
Any capital loss carryback to the current tax year
The following steps are used in applying the calculations for DRD
Multiply the dividends received by the deduction percentage
Multiply the taxable income (calculated above) by the deduction percentage
Limit the deduction to the lesser of step 1 or step 2. If deducting the amount in step 1 results in an NOL, the amount in step 1 is used (NOL rule)
Calculation
X Corporations Y Corporations Z Corporations Gross Income from operations $600,000 $480,000 $320,000 Expenses from operations ($490,000) ($490,000) ($490,000) Dividends received from domestic corporations (< 20% Ownership $300,000 $300,000 $300,000 Taxable Income before DRD $410,000 $290,000 $130,000 Three-step procedure for DRD Step 1: (50% x $300,000) $150,000 $150,000 $150,000 Step 2 50% x $410,000 $210,000 50% x $290,000 $145,000 50% x $130,000 $65,000 Step 3 Lesser of Step 1 or Step 2 $150,000 $145,000 $150,000 (*)
In the example, DRD for X and Y Corporations are straight forward which is $150,000 for X Corporation and $145,000 for Y Corporation.
(*) Z Corporation qualifies for NOL rule treatment because subtracting $150,000 (step 1) from $130,000 taxable income before DRD results a negative number. So Z Corporation can deduct $150,000,
Important Notes
Some important notes in order to qualify for DRD
Hold stock for 45 days under most situations (IRC section 246(c))
The standard rate of deduction (50%, 65% an 100% for 2018) applies for domestic corporations
For planning purposes, Corporations should consider the timing of income and deductions to qualify NOL rule. This rule may result in a significant amount of a corporation’s DRD.