Dividends Received Deduction (DRD)
What Is the Dividends Received Deduction?
The Dividends Received Deduction (DRD) is a federal tax deduction in the United States that allows a corporation to deduct a percentage of the dividends it receives from other corporations, designed to alleviate the burden of triple taxation.
In the US tax system, corporate income is taxed. Then, when that income is paid out as dividends to shareholders, the shareholders are taxed again. This is "double taxation." Now imagine Corporation A owns stock in Corporation B. 1. Corp B earns profit (Taxed). 2. Corp B pays dividend to Corp A (Taxed again?). 3. Corp A pays dividend to its shareholders (Taxed a third time?). To prevent this "triple taxation," the IRS allows Corporation A to deduct a significant portion of the dividends received from Corporation B from its taxable income. This is the **Dividends Received Deduction (DRD)**.
Key Takeaways
- Applies only to C-Corporations (not individuals or S-Corps).
- Deduction is 50%, 65%, or 100%, depending on ownership stake.
- Prevents income from being taxed multiple times as it moves between companies.
- Requires a holding period of at least 46 days.
- Does not apply to dividends from REITs or certain foreign corps.
How It Works: The Tiers
The amount of the deduction depends on how much of the paying company the receiving company owns (as of the Tax Cuts and Jobs Act of 2017): **1. Less than 20% Ownership:** The deduction is **50%**. *(If Corp A receives $100 dividend, only $50 is taxable).* **2. 20% to 80% Ownership:** The deduction is **65%**. *(If Corp A receives $100 dividend, only $35 is taxable).* **3. 80% or More Ownership:** The deduction is **100%**. *(If Corp A receives $100 dividend, $0 is taxable).* This usually applies to parent-subsidiary relationships.
Requirements and Limitations
To qualify for the DRD, the corporation must hold the stock for at least **46 days** during the 91-day period beginning 45 days before the ex-dividend date. This prevents companies from buying a stock just for the dividend and selling it immediately (dividend stripping). The DRD does **not** apply to: * Dividends from Real Estate Investment Trusts (REITs). * Dividends from tax-exempt corporations. * Dividends regarded as capital gain distributions. * Most foreign corporations (though there is a separate 100% deduction for the foreign-source portion of dividends from 10%-owned foreign corps).
Real-World Example
Corporation X buys stock in General Electric (GE). It owns 5% of GE. It receives $100,000 in dividends.
Strategic Implications
The DRD makes dividend-paying preferred stock very attractive to corporate treasurers. Corporations can invest their excess cash in high-quality preferred stocks and receive a high after-tax yield compared to bonds (interest income is fully taxable; it gets no deduction).
Common Beginner Mistakes
Misunderstandings:
- Thinking individuals can claim DRD (Only C-Corps can).
- Applying DRD to interest income (Only applies to equity dividends).
- Ignoring the 45-day holding period rule.
FAQs
To ensure fairness. Without it, corporate profits circulating within the corporate sector would be taxed over and over again, leaving almost nothing for the final individual shareholder. It encourages inter-corporate investment.
Generally, no. Pass-through entities like LLCs, S-Corps, and Partnerships pass the income directly to owners, who are taxed at individual rates. The DRD is specifically for C-Corps subject to corporate income tax.
If a corporation borrows money to buy the dividend-paying stock, the DRD is reduced. The IRS doesn't want you to deduct the interest expense *and* the dividend income simultaneously.
Yes. Ownership is typically determined by both vote and value of the stock held.
Yes. Before 2018, the rates were 70% and 80%. The Tax Cuts and Jobs Act lowered them to 50% and 65% because the overall corporate tax rate was slashed from 35% to 21%.
The Bottom Line
The Dividends Received Deduction is a crucial tax provision that facilitates the flow of capital between corporations. While irrelevant to individual investors, it drives the investment strategies of insurance companies and corporate treasuries, making dividend stocks a tax-efficient place to park corporate cash.
More in Tax Compliance & Rules
At a Glance
Key Takeaways
- Applies only to C-Corporations (not individuals or S-Corps).
- Deduction is 50%, 65%, or 100%, depending on ownership stake.
- Prevents income from being taxed multiple times as it moves between companies.
- Requires a holding period of at least 46 days.