- Learn how to calculate the dividends-received deduction.
- Discover information about the holding period for the deduction.
- Learn about the taxable income limitation.
- Find an example of the dividends-received deductible.
There’s a valuable tax deduction available to a C corporation when it receives dividends. The “dividends-received deduction” is designed to reduce or eliminate an extra level of tax on dividends received by a corporation. As a result, a corporation will typically be taxed at a lower rate on dividends than on capital gains.
Calculating the dividends-received deduction
Ordinarily, the deduction equals 50% of the dividend. So only 50% of the dividend received is effectively subject to tax. For example, if your corporation receives a $1,000 dividend, it includes $1,000 in income. However, after the $500 dividends-received deduction, its taxable income from the dividend is only $500.
The deductible percentage of a dividend will increase to 65% of the dividend if your corporation owns 20% or more (by vote and value) of the payor’s stock. What if the payor is a member of an affiliated group (based on an 80% ownership test)? Then dividends from another group member are 100% deductible. (If one or more members of the group are subject to foreign taxes, a special rule requiring consistency in the treatment of foreign taxes applies.) In applying the 20% and 80% ownership percentages, preferred stock isn’t counted if it’s limited and preferred as to dividends, doesn’t participate in corporate growth to a significant extent, isn’t convertible, and has limited redemption and liquidation rights.
If a dividend on stock that hasn’t been held for more than two years is an “extraordinary dividend,” the basis of the stock on which the dividend is paid is reduced by the amount that effectively goes untaxed because of the dividends-received deduction. If the reduction exceeds the basis of the stock, gain is recognized. (A dividend paid on common stock will be an extraordinary dividend if it exceeds 10% of the stock’s basis, treating dividends with ex-dividend dates within the same 85-day period as one.)
Holding period requirement for the dividends-received deduction
The dividends-received deduction is only available if the recipient satisfies a minimum holding period requirement. In general, this requires the recipient to own the stock for at least 46 days during the 91-day period beginning 45 days before the ex-dividend date. For dividends on preferred stock attributable to a period of more than 366 days, the required holding period is extended to 91 days during the 181-day period beginning 90 days before the ex-dividend date. Under certain circumstances, periods during which the taxpayer has hedged its risk of loss on the stock are not counted.
Taxable income limitation
The dividends-received deduction is limited to a certain percentage of income. What if your corporation owns less than 20% of the paying corporation? Then the deduction is limited to 50% of your corporation’s taxable income (modified to exclude certain items). However, what if allowing the full (50%) dividends-received deduction without the taxable income limitation would result in (or increase) a net operating loss deduction for the year? Then the limitation doesn’t apply.
An illustrative example of the dividends-received deduction
Say your corporation receives $50,000 in dividends from a less-than-20% owned corporation. It also has a $10,000 loss from its regular operations. If there were no loss, the dividends-received deduction would be $25,000 (50% of $50,000). However, since the taxable income used in computing the dividends-received deduction is $40,000, the deduction is limited to $20,000 (50% of $40,000).
Other rules apply if the dividend payor is a foreign corporation. Want to discuss how to take advantage of this deduction? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.