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The Dividends Received Deduction, or DRD, is a tax deduction that C corporations receive on the dividends distributed to them by other companies whose stock they own. As a C corporation's equity interest in a dividend-paying company increases, so does the amount of the DRD as shown below:

 PercentOwnership Dividends ReceivedDeduction Implied Tax Rateon Dividends* < 20% 70% 10.5% [= 35% × (1-70%)] 20 - 80% 80% 7.0% [= 35% × (1-80%)] > 80% 100% 0.0% [= 35% × (1-100%)]

* Assumes a 35% tax rate for the corporation receiving the dividend.

The DRD is designed to soften the blow of triple taxation on corporate dividends. Triple taxation occurs because the company paying the dividend does so with after-tax money. The C corporation receiving the dividend is then taxed on the dividend. Finally, if the receiving C corporation pays out the dividend to its shareholders, the shareholders are taxed yet again.

There are a few limitations to the DRD:

• The DRD is only available to C corporations; not LLCs, S corporations, or individuals.
• There is a 45-day minimum holding period for common stock.
• The DRD does not apply to preferred stock.
• If a corporation is entitled to a 70% DRD, it can deduct dividends only up to 70% of its taxable income.
• If a corporation is entitled to a 80% DRD, it can deduct dividends only up to 80% of its taxable income.

If a corporation is entitled to a 100% DRD, there is no taxable income limitation. Also, if the DRD creates or increases a net operating loss, the taxable income limitations do not apply.

### Example A

Corporation X owns 40% of Corporations Y's outstanding stock. Corporation X has taxable income of \$900, which includes dividends of \$1,000. What is Corporation X's taxable income after the DRD?

At first glance, Corporation X could deduct \$800 (=80%×\$1,000) of dividends based on stock ownership alone. However, the taxable income limitation limits the deduction to 80% of Corporation X's taxable income, or \$720 (=80%×\$900).

 Taxable Income Before DRD \$900 ( – ) DRD (720) Taxable Income After DRD \$180

### Example B

Use the facts from Example 3.9, except now assume that Corporation X's taxable income is \$700. What is Corporation X's taxable income after the DRD?

Corporation X can now deduct the full \$800 (=80%×\$1,000) of dividends. The taxable income limitation does not apply because the DRD creates a net operating loss.

 Taxable Income Before DRD \$700 ( – ) DRD (800) Taxable Income After DRD (\$100)

If a corporation claims both a 70% DRD and an 80% DRD, first calculate the taxable income limit for the 80% DRD. Then, in order to calculate the taxable limit for the 70% DRD, reduce the taxable income by the total amount of the dividends subject to the 80% DRD.

### Example C

Corporation X has \$1,000 of taxable income, inclusive of dividends. It owns 15% of the stock of Corporation Y from which it receives \$400 in dividends, and 40% of the stock of Corporation Z from which it receives \$700 in dividends. How much can Corporation X deduct?

First, calculate the the 80% DRD. The allowable deduction is the smaller of the tentative DRD of \$560 (=80%×\$700) or 80% of its taxable income or \$800 (=80%×\$1,000) taxable income.

Next, calculate the 70% DRD. The allowable deduction is the smaller of the tentative DRD of \$280 (=70%×\$400) or 70% of its taxable income after deducting dividends from Corporation Z, or \$210 [=70%×(\$1,000−\$700)].

 Taxable Income Before DRD \$1,000 ( – ) DRD [=\$560+\$210] (770) Taxable Income After DRD \$230