Dividends Received Deduction
Kyle Ashcraft, CPA · 2019 CPA Exam Scores · 95 FAR · 98 BEC · 91 REG · 90 AUD
One dollar of corporate income taxed three times sounds like a drafting error, not tax policy. The dividends received deduction exists specifically to stop that from happening.
Why does the dividends received deduction exist?
Say Company A owns stock in Company B, and both are C corporations. Without a fix, the same dollar of income gets taxed three separate times:
- Company B earns income and pays corporate tax on it.
- Company B distributes a dividend to Company A, which pays corporate tax on that dividend.
- Company A distributes a dividend to its own shareholder, who pays individual tax on it.
The dividends received deduction (DRD) removes the second layer: it lets Company A exclude some or all of the dividend it received from Company B from its own taxable income.
How much of the dividend can you deduct?
The deduction percentage depends on how much of the paying corporation you own:
| Ownership in the paying corporation | Deduction |
|---|---|
| Less than 20% | 50% |
| 20% up to 80% | 65% |
| 80% or more | 100% |
Less than 20% ownership, 50% deduction. 20–80%, 65%. 80%+, 100%. More ownership means a bigger deduction, up to a full exclusion once the corporations are affiliated enough to file a consolidated return.
Can the DRD ever create a net operating loss?
Normally, no — the DRD is capped at a percentage of taxable income (computed before the DRD, the NOL deduction, and a few other items), using the same percentage as the deduction tier above. That cap exists to stop the DRD from manufacturing a loss out of otherwise-profitable income.
But there's an exception, and it's the part of this rule the exam actually tests: the taxable-income cap is waived if taking the full, uncapped DRD would create or increase a net operating loss. In that specific case, the corporation deducts the full DRD amount — even though doing so creates or deepens an NOL.
Work it in two steps. First, compute the DRD two ways: the full percentage of the dividend, and the percentage of taxable income. Normally you're stuck with the smaller of the two. Then check: does using the full amount create or increase an NOL? If yes, use the full amount anyway — the income cap no longer applies.
What else can reduce or wipe out the DRD?
Two limitations show up regularly on the exam, and both are easy to miss.
The holding period requirement
To claim the DRD, the corporation must hold the stock for more than 45 days within the 91-day window centered on the ex-dividend date (more than 91 days within a 181-day window for certain preferred stock). Buy the stock right before the ex-dividend date and sell it right after, and the DRD disappears entirely — this is the single most common DRD trap on practice questions.
Debt-financed portfolio stock
If the corporation bought the stock with borrowed money, the DRD is reduced in proportion to how much of the purchase was debt-financed. Pay cash for the stock and this reduction doesn't apply.
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Kyle Ashcraft, CPA scored 90 or above on every section of the CPA exam in 2019, including a 91 on REG. He is the founder and sole instructor of Maxwell CPA Review, a complete CPA review course covering all six sections, where he creates every lecture, textbook and study outline himself.
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