What Is the Dividends Received Deduction (DRD)?

The dividends received deduction (DRD) is a federal tax write-off in the U.S. applicable to certain corporations that receive dividends from related entities. The deduction 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.

How the Dividends Received Deduction (DRD) Works

The DRD 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.

There are three tiers of possible deductions. First, the general rule states that the DRD is equal to 70% of the dividend received. Second, if the company receiving the dividend owns more than 20% but less than 80% of the company paying the dividend, the DRD amounts to 80% of the dividend received. Finally, if the company receiving the dividend owns more than 80% of the company paying the dividend, the DRD equates to 100% of the dividend.

Note that a taxable income limitation also applies to DRD stipulations. Under this rule, which affects dividends received from companies in which the payee has less than 80% ownership, the DRD equals 70% or 80% of its taxable income figure if the taxable income of the corporation receiving the dividend is less than what the DRD would otherwise be. However, the taxable income limitation does not apply if the DRD creates or adds to a net operating loss.

Another technical rule is that, in order to receive the dividend to claim the DRD, the company must have owned the shares of the company paying the dividend for at least 45 days prior to the dividend payment.

Example of a Dividends Received (DRD) Deduction

Assume that ABC Inc. owns 60% of its affiliate, DEF Inc. If ABC has taxable income of $10,000, and including a dividend of $9,000 from DEF, it would be entitled to a DRD of $7,200, or 80% of $9,000.

However, if ABC's income was $9,000 including a dividend of $10,000, then the income limitation rule would apply. Fundamentally, in light of its 60% ownership, ABC should have been entitled to a DRD equal to $10,000 X 80%, or $8,000. However, the DRD is limited to 80% of ABC's taxable income, or $7,200 ($9,000 X 80%).

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 three tiers of possible deductions.
  • There are several rules that need be followed for corporate shareholders to be entitled to the DRD.