Key Takeaways
- The DRD reduces multi-layer taxation on corporate dividends.
- DRD percentage: 50% (<20% ownership), 65% (20-80%), 100% (80%+).
- DRD is limited to a percentage of taxable income.
- Exception: No limitation if DRD creates NOL.
- Reported on Schedule C of Form 1120.
- Applies only to dividends from domestic corporations.
Dividends Received Deduction (DRD)
Why This Matters for the Exam
The DRD prevents triple taxation when corporations own stock in other corporations. The exam tests the percentages, the ownership thresholds, and the taxable income limitation.
Expect at least 3-4 questions on DRD.
Purpose of the DRD
Without DRD, corporate profits could be taxed three times:
| Level | Tax |
|---|---|
| Distributing corporation | 21% |
| Receiving corporation | 21% on dividend |
| Individual shareholder | 0-20% on dividend from receiving corp |
The DRD reduces the receiving corporation's tax on dividends.
DRD Percentages
| Ownership in Distributing Corporation | DRD Percentage |
|---|---|
| Less than 20% | 50% |
| 20% to less than 80% | 65% |
| 80% or more (affiliated group) | 100% |
DRD Calculation Example
| Scenario | Calculation |
|---|---|
| Corp B owns 15% of Corp A | <20% ownership |
| Corp A pays $10,000 dividend | |
| DRD | $10,000 × 50% = $5,000 |
| Taxable dividend | $10,000 - $5,000 = $5,000 |
| Tax (21%) | $5,000 × 21% = $1,050 |
Taxable Income Limitation
The DRD is limited to the applicable percentage of taxable income (computed without the DRD, NOL deduction, and certain other items).
| DRD Ownership | TI Limitation |
|---|---|
| <20% | 50% of taxable income |
| 20-80% | 65% of taxable income |
| 80%+ | No limitation |
NOL Exception
Exception: If taking the full DRD would create or increase an NOL, the taxable income limitation does not apply.
| Scenario | Limitation Applies? |
|---|---|
| Taxable income is positive after DRD | Yes |
| Full DRD creates NOL | No (take full DRD) |
| Full DRD increases existing NOL | No (take full DRD) |
Taxable Income Limitation Example
| Item | Amount |
|---|---|
| Dividend received (10% ownership) | $100,000 |
| Taxable income before DRD | $60,000 |
| Tentative DRD (50%) | $50,000 |
| TI limitation (50% × $60,000) | $30,000 |
| DRD allowed | $30,000 (limited) |
Check NOL Exception:
- Taxable income after full DRD: $60,000 - $50,000 = $10,000 (positive).
- Limitation applies—DRD is $30,000.
Affiliated Groups (100% DRD)
| Affiliated Group | Rule |
|---|---|
| Ownership | Parent owns 80%+ of subsidiary |
| DRD | 100% |
| Effect | Inter-company dividends are tax-free |
| TI Limitation | None |
Qualifying Dividends
| Qualifies for DRD | Does Not Qualify |
|---|---|
| Domestic corporation dividends | Foreign corporation dividends |
| C corporation dividends | Tax-exempt organization dividends |
| Debt-financed portfolio stock |
Real-World Scenario
Scenario: Corp X owns 25% of Corp Y. Corp Y pays a $80,000 dividend to Corp X. Corp X has taxable income of $100,000 before the DRD.
- Ownership: 20-80% → 65% DRD.
- Tentative DRD: $80,000 × 65% = $52,000.
- TI Limitation: $100,000 × 65% = $65,000.
- DRD allowed: $52,000 (tentative < limitation).
On the Exam
Expect 3-4 questions on DRD, typically:
- Percentage Questions: "What DRD applies to 15% ownership?"
- Calculation Questions: "Calculate the DRD for a dividend received."
- Limitation Questions: "When does the taxable income limitation apply?"
- Affiliated Group Questions: "What DRD applies to 80%+ ownership?"
The key is to remember: <20% = 50%, 20-80% = 65%, 80%+ = 100%. Limited to % of TI unless creates NOL.
Corp X owns 15% of Corp Y. Corp Y pays a $50,000 dividend. What is the DRD?
What DRD percentage applies to 25% ownership?
Parent Corp owns 90% of Subsidiary. Subsidiary pays $100,000 dividend. What is the DRD?