Dividends received deduction
The dividends-received deduction (or "DRD"), under U.S. federal income tax law
Income tax in the United States
In the United States, a tax is imposed on income by the Federal, most states, and many local governments. The income tax is determined by applying a tax rate, which may increase as income increases, to taxable income as defined. Individuals and corporations are directly taxable, and estates and...

, is a tax deduction
Tax deduction
Income tax systems generally allow a tax deduction, i.e., a reduction of the income subject to tax, for various items, especially expenses incurred to produce income. Often these deductions are subject to limitations or conditions...

 received by a corporation
A corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter...

 on the dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...

s paid to it by other corporations in which it has an ownership stake.


This deduction is designed to reduce the consequences of triple taxation. Otherwise, corporate profits would be taxed to the corporation that earned them, then to the corporate shareholder, and then to the individual shareholder. While Congress allowed for double taxation on corporations, it did not intend a triple - and potentially infinitely-tiered - tax to apply to corporate profits at every level of their distribution.

The dividends-received deduction complements the consolidated return regulations, which allow affiliated corporations to file a single consolidated return for U.S. federal income tax purposes.


Generally, if a corporation receives dividends from another corporation, it is entitled to a deduction of 70 percent of the dividend it receives. If the corporation receiving the dividend owns 20 percent or more, however, then the amount of the deduction increases to 80 percent. If, on the other hand, the corporation receiving the dividend owns more than 80 percent of the distributing corporation, it is allowed to deduct 100 percent of the dividend it receives.

Note that in order for the deduction to apply, the corporation paying the dividend must also be liable for tax (i.e., it must be subject to the double taxation that the deduction is intended to prevent).


The Taxable Income Limitation -
The dividends received deduction is limited with regards to the corporate shareholder’s taxable income. Per §246(b) of the IRC, a corporation with the rights to a seventy percent dividends received deduction, can deduct the dividend amount only up to seventy percent of the corporation’s taxable income. Furthermore, a corporation with the rights to an eighty percent dividends received deduction can deduct the dividend amount only up to eighty percent of the corporation’s taxable income. However, no taxable income restriction is placed on a corporation with a one-hundred percent dividends received deduction.

For purposes of determining the appropriate dividends received deduction, a corporate shareholder’s taxable income should be computed without including net operating losses (NOL’s), capital loss carrybacks, and the dividends received deduction. However, the taxable income limitation does not apply to corporate shareholders who experience an NOL in the current taxable year.

The Holding Period Limitation –
In order to receive the tax benefit of a dividends received deduction, a corporate shareholder must hold all shares of the distributing corporation’s stock for a period of more than 45 days. Per §246(c)(1)(A), a dividends received deduction is denied under §243 with respect to any share of stock that is held by the taxpayer for 45 days or less.

The complexity of this limitation is amplified per §246(c)(4). Section 246(c)(4) states that the stock’s holding period is reduced for any period in which the taxpayer has an option to sell, is under a contractual obligation to sell, or has made a short sale of substantially identical securities. In revenue ruling 94-28, the Internal Revenue Service (IRS) explains that the principle behind §246(c)(4) is to deny credit toward the 45-day holding period for any period during which the taxpayer is protected from the risk of loss inherent in the ownership of an equity interest.

Debt-financed Dividends Received Limitation –
Code Section 246A disallows the benefit of the dividends received deduction for debt financed purchases of corporate portfolio stock. As stated by the Joint Committee on Taxation, the provision reduces the deduction for dividends received on debt-financed portfolio stock. Therefore, the dividends received deduction is available only with respect to dividends “attributable” to stock financed through other means besides debt. A simple ratio is computed to determine what percentage of an investment is debt-financed. As a result, the dividends received deduction is reduced by the percentage of the investment funded by debt.
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