The dividends received deduction is a rare example of a deduction applied to money received, rather than spent, in US federal income tax regulations. It limits double taxation and has three levels of deduction depending on the percentage of shares owned. Deductions are limited by the corporation’s taxable income and the deduction only applies to shares held for at least 45 days.
A deduction for dividends received is a specific term in the United States federal income tax regulations. Refers to a deduction granted to a corporation to cover dividends received from another corporation that it partly owns. As a result, it is a rare example of a deduction applied to money the taxpayer has received, rather than spent.
The purpose of the dividends received deduction is to limit the effects of the same money being taxed repeatedly. United States policy allows for double taxation, which is the circumstance in which a company’s profits are taxed and then shareholders are taxed on dividends they receive from the company’s after-tax profits. Without the dividends received deduction, there would be an additional layer of taxes: taxes would be taken from the profits of one corporation, the dividend paid to a second corporation with an ownership interest in the first corporation, and the dividends paid by the second corporation to individual shareholders.
There are three levels of dividends received deduction. If a corporation owns less than 20% of the shares of another corporation, it can deduct 70% of the dividends received from that share from its own taxable income. If the corporation owns more than 20% of the shares of the other corporation, the proportion of dividends that can be deducted increases to 80%. If the corporation owns more than 80% of the shares of the other corporation, it can deduct dividends in full.
There are some limitations on deductions. Where a business can deduct 70% or 80% of dividends from its taxable income, the deduction cannot exceed 70% or 80% of its own taxable income, respectively. That means that in a situation where a company receives more dividends than its own pre-tax earnings, it will be able to list a zero figure of taxable income for the year, but the excess deduction amount will be ignored. A company that is allowed to deduct the full amount of the dividend may list negative taxable income, which means that some of the “losses” will typically carry over and be offset against next year’s income figures.
The deduction for dividends received only applies to shares that the corporation has held for at least 45 days. This period cannot cover any time during which the corporation had the right or option to sell the shares at a fixed price. The principle of this rule is that deduction benefits are only available to corporations that carry the risks inherent in stock ownership.
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