In the last blog post, Would You Rather Be Taxed Once or Twice?, we discussed that the major disadvantage of corporations is that its profits are taxed twice: once at the corporate level, and once at the shareholder level. But what if a corporation owns another corporation? Would the income from the second corporation be subject to triple taxation?
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The answer is... maybe and to a certain extent.
Does that clarify things?
In order to lessen the potential impact of triple taxation, within the Internal Revenue Code there is a corporate tax deduction known as the "dividends received deduction."
What the dividends received deductions does is allow a corporate shareholder to deduct from its income a certain percentage of the dividends it receives from other corporations that it owns based upon its ownership percentage.
If a corporate shareholder owns less than 20% of another corporation, it is entitled to deduct from its income 70% of the dividends it receives from that corporation. If the corporate shareholder owns between 20% and 80% of another corporation, then it is entitled to deduct 80% of the dividends it receives from that corporation. Finally, it a corporation owns greater than 80% of another corporation, it is entitled to deduct 100% of the dividends it receives from that corporation.
There are several limitations placed upon the dividends received deduction, including the: taxable income limitation, the holding period limitation, and the debt-financed dividends received limitation.
Under the taxable income limitation, the amount of the dividend received deduction cannot exceed a certain percentage of the corporation's taxable income. For corporations that would be entitled to a 70% dividends received deduction, the amount of the deduction cannot be greater than 70% of the corporation's taxable income. Likewise, for corporations that would be entitled to an 80% dividends received deduction, the amount of the deduction cannot be greater than 80% of the corporation's income. However, there is no such restriction for corporations that would be entitled to a 100% dividends received deduction. Also, the taxable income limitation does not apply if the dividends received deduction either creates or increases a corporation's net operating loss.
Under the holding period limitation, a corporate shareholder must hold the shares of the distributing corporation's stock for a period of more than 45 days.
Under the debt-financed dividends received limitation, the deduction is disallowed if debt was used to finance the purchase of the other corporation's stock. Therefore, if a percentage of the stock was purchased using debt, then the dividends received deduction is reduced by that percentage.
If you would like to learn more about the dividend received deduction, please feel free to send me an e-mail.
Under the taxable income limitation, the amount of the dividend received deduction cannot exceed a certain percentage of the corporation's taxable income. For corporations that would be entitled to a 70% dividends received deduction, the amount of the deduction cannot be greater than 70% of the corporation's taxable income. Likewise, for corporations that would be entitled to an 80% dividends received deduction, the amount of the deduction cannot be greater than 80% of the corporation's income. However, there is no such restriction for corporations that would be entitled to a 100% dividends received deduction. Also, the taxable income limitation does not apply if the dividends received deduction either creates or increases a corporation's net operating loss.
Under the holding period limitation, a corporate shareholder must hold the shares of the distributing corporation's stock for a period of more than 45 days.
Under the debt-financed dividends received limitation, the deduction is disallowed if debt was used to finance the purchase of the other corporation's stock. Therefore, if a percentage of the stock was purchased using debt, then the dividends received deduction is reduced by that percentage.
If you would like to learn more about the dividend received deduction, please feel free to send me an e-mail.
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