The Dividends-Received Deduction

Corporations cannot deduct the dividends they pay out to shareholders. But C corporations may be able to claim a special deduction for a percentage of certain stock dividends they receive. This is called a dividends-received deduction. Other taxpayers—individuals, partnerships, LLCs, and S corporations—cannot claim this deduction.

Percentages of the Dividends-Received Deduction

The percentage of the dividend that can be deducted depends on the amount of stock your corporation owns and the type of company paying the dividends. Other factors may operate to further limit the percentage.

FORTY-TWO PERCENT DEDUCTION

If your corporation owns less than 20% of the preferred stock issued before October 1992 of a taxable public utility, your dividends-received deduction is limited to 42% of the dividends received from that public utility. If your corporation owns more than 20% of the utility, the dividends-received deduction increases to 48%.

SEVENTY PERCENT DEDUCTION

If your corporation owns less than 20% of the stock of the dividend-paying corporation, your dividends-received deduction is 70% of the dividends you receive from that corporation.

EIGHTY PERCENT DEDUCTION

If your corporation owns at least 20% of the stock of the dividend-paying corporation, your dividends-received deduction is 80% of the dividends you receive from that corporation.

ONE HUNDRED PERCENT DEDUCTION

If your corporation and the dividend-paying corporation are members of an affiliated group, all of the dividends received are deductible. The full deduction also applies to small business investment companies that receive dividends from domestic corporations.

Other Limits on the Dividends-Received Deduction

In addition to the percentage limitation, other limits may apply to reduce or eliminate entirely the deduction.

LIMIT FOR DEBT-FINANCED PORTFOLIOS

If your corporation borrows to buy or carry a stock portfolio, the 70% and 80% dividends-received deductions must be reduced by the percentage related to the amount of debt.

OVERALL LIMIT

There is an overall limit on the deduction for dividends received. This limit is calculated on Schedule C of Form 1120.

NO DEDUCTION ALLOWED

Certain types of deductions do not qualify for the dividends-received deduction. These include dividends from:

• Foreign corporations (with limited exceptions).
• Real estate investment trusts.
• Corporations whose stock has been held for only 46 days or less during the 90-day period beginning on the date that is 45 days before the date on which the shares become ex-dividend.
• Corporations whose stock has been held for 91 days or less during the 180-day period beginning on the date that is 90 days before the date on which the shares became ex-dividend, if the stock has preference as to dividends and the dividends received on it are attributable to a period of more than 365 days.
• Tax-exempt corporations.
• Corporations to which your corporation is obligated (pursuant to a short sale or otherwise) to make related payments for positions in substantially similar or related property.

See Table 22.3 for a checklist of deductible and nondeductible expenses.

TABLE 22.3 Checklists of Deductible and Nondeductible Expenses