Dividends Received Deduction
Now, let’s discuss the dividends received deduction. This deduction is designed to avoid triple taxation. This deduction applies when one C Corp owns another C Corp. Consider that my C Corp (Company A) owns another C Corp (Company B). When the C Corp I bought (Company B) has income, it pays taxes on that income (1st tax). Then when it gives a dividend to Company A, Company A pays taxes on it (2nd tax). Then when Company A sends a dividend to me, the shareholder, I pay tax on it (3rd tax).
This scenario would result in triple taxation. Hence, we have the dividends received deduction to reduce triple taxation. This is the portion of the dividends received from another C Corp that isn’t taxable, and it depends on the percentage ownership you have in that company.
Dividends Received Deduction Amounts:
- 0-20% Ownership is a 50% Deduction
- 20-80% Ownership is 65% Deduction
- 80% Ownership is 100% Deduction
With 0-20% ownership, 50% of the dividend is deductible. For 20-80% ownership, 65% of it is deductible, and for more than 80% ownership, 100% of it is deductible.
The dividend received deduction is not allowed to create a net operating loss.
There are two types of C Corps that cannot use this deduction: a personal service corporation and a personal holding company.
A personal service corporation is a C Corp that:
- Generates most of its income from service revenue, and
- Most revenue comes from individuals who own more than 10% of the company.
If it meets these two criteria, it’s classified as a personal service corporation.