Dividends Received Deduction (DRD): A Practical Guide

Key takeaways
* The Dividends Received Deduction (DRD) lets U.S. corporations deduct a portion of dividends received from other corporations to reduce double or triple taxation.
* The deduction percentage depends on ownership in the dividend-paying company and whether dividends are domestic or foreign.
* Certain dividends (e.g., from REITs, some RIC distributions) and some tax-exempt distributors are ineligible for the DRD.
* Special holding-period and taxable-income limits may affect the amount of DRD a corporation can claim.

What the DRD is and why it exists

The DRD is a U.S. corporate tax provision that reduces taxable income for corporations that receive dividends from other corporations. It exists primarily to mitigate the economic burden of taxing the same corporate earnings multiple times—when earned, when passed to an intermediate corporate shareholder, and again when distributed to ultimate shareholders.

How the DRD works

• The percentage of the dividend that can be deducted depends on the receiving corporation’s ownership stake in the dividend payer.
• Under current rules for tax years beginning after Dec. 31, 2017:
• If the receiving corporation owns less than 20% of the distributing corporation, it may generally deduct 50% of the dividends received (subject to limits).
• If the receiving corporation owns 20% or more, it may generally deduct 65% of the dividends received (subject to limits).
• Small business investment companies are permitted to deduct 100% of dividends they receive from taxable domestic corporations.
• Dividend deductions can be constrained by taxable-income limitations; special rules may apply when a corporation has a net operating loss (NOL) for the tax year.

Common exceptions and ineligible dividends

Corporations cannot claim the DRD for all dividend types. Notable exclusions include:
* Dividends from real estate investment trusts (REITs).
* Certain dividends paid by entities exempt under IRC sections 501 or 521 for the distribution year or the prior year.
* Capital gain dividends paid by regulated investment companies (RICs).
* Other distributions that do not meet the statutory definition of a taxable dividend for DRD purposes.

Foreign-source dividends

Rules differ for dividends from foreign corporations:
* In many cases, corporations can deduct 100% of the foreign-source portion of dividends received from foreign corporations in which they own at least 10% of the stock.
* A minimum holding period is required—typically at least 365 days—to qualify for the DRD on such foreign-source dividends.
* Additional sourcing and anti-abuse rules may apply.

Illustrative example

ABC Inc. owns 60% of DEF Inc. ABC has taxable income of $10,000 and receives a $9,000 dividend from DEF. If ABC qualifies for the 65% DRD (because it owns 60% of DEF), the deduction on the dividend would be:
* DRD = 65% × $9,000 = $5,850

Practical considerations and filing

• The DRD can be limited by taxable-income based ceilings and other statutory limits; corporations should calculate whether the deduction reduces taxable income below allowable thresholds.
• Holding-period requirements must be met for the DRD to apply in many cases.
• Corporations generally report and claim the DRD on their corporate income tax return (Form 1120) following IRS instructions.
• For detailed rules, exceptions, and worksheets, consult IRS Publication 542 and the Form 1120 instructions.

Bottom line

The DRD is an important tool for corporate taxpayers to reduce the tax burden associated with intercorporate dividend flows. Eligibility and the deductible percentage hinge on ownership levels, the type and source of the dividend, and specific statutory limits. Corporations should confirm holding-period requirements and taxable-income limitations and consult IRS guidance or a tax advisor when calculating and claiming the deduction.

Further reading
* IRS Publication 542, Corporations
* Instructions for Form 1120