What Is the Dividends Received Deduction (DRD)?

The dividends received deduction (DRD) is a federal tax deduction in the U.S. that is given to certain corporations that get dividends from related entities. The amount of the dividend that a company can deduct from its income tax is tied to how much ownership the company has in the dividend-paying company. However, there are criteria that must be met in order to qualify for a DRD. 

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, ranging from a 70% deduction of the dividend received up to 100%. 
  • But are several rules that need to be followed for corporate shareholders to be entitled to the DRD.

How the Dividends Received Deduction (DRD) Works

The dividends received deduction 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.

The deduction received 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.

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.

Special Considerations

Note that a taxable income limitation also applies to DRD stipulations. This rule affects dividends received from companies in which the payee has less than 80% ownership. The rule applies if the taxable income figure of the dividend-receiving company is less than what the DRD would be otherwise. In other words, the DRD cannot create an operating loss for the company.

In the case that the taxable income limitation is met, the DRD equals the percentage (70% or 80% depending on the ownership—as laid out above) of the taxable income. However, the taxable income limitation does not apply if the dividend-receiving company has a net operating loss.

Example of a Dividends Received (DRD) Deduction

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

However, if ABC's income was $9,000 and it received a dividend of $11,000, then the income limitation rule would apply. Fundamentally, in light of its 60% ownership, ABC should have been entitled to a DRD equal to $12,000 * 80%, or $9,600. However, the DRD is limited to 80% of ABC's taxable income, or $7,200 ($9,000 * 80%), since the DRD would create a loss for the company.