Question

Problem 13-21 (LO. 1, 3) Black Corporation and Tom each own 50% of Tan Corporation's common stock. On January 1, Tan holds a deficit in accumulated E & P of $200,000. Its current E & P is $90,000. During the year, Tan makes cash distributions of $40,000 each to Black and Tom. Click here to view the Dividend Received Deduction Table. a. Complete the statements below that outline how the two shareholders are taxed on the distribution. Black Corporation has dividend income of $ 0 X and is entitled to a dividends received deduction of $ o X . Tom has dividend income of $ Ox, which $ 0 X is taxed at the preferential income tax rate. Feedback Check My Work The importance of corporate distributions derives from the variety of tax treatments that may apply. From the shareholder's perspective, distributions received from the corporation may be treated as ordinary income, preferentially taxed dividend income, capital gain, or a nontaxable recovery of capital. From the corporation's perspective, distributions made to shareholders are generally not deductible.

Answer 1

A distribution from a corporation is a dividend to the extent of the corporation’s current-year E&P and accumulated E&P. A distribution will be treated as a dividend to the extent of a corporation’s current-year E&P, even if the corporation has an accumulated E&P deficit.

The dividends received deduction (DRD) is a federal tax deduction in the U.S. that is given to certain corporations that get dividends from related entities.  However, there are criteria that must be met in order to qualify for a DRD.

KEY TAKEAWAYS

• The dividends received deduction (DRD) applies to certain corporations that receive dividends from related entities and alleviates the potential consequences of triple taxation.
• There are three tiers of possible deductions, ranging from a 70% deduction of the dividend received up to 100%.
• But are several rules that need to be followed for corporate shareholders to be entitled to the DRD.

The dividends received deduction allows a company that receives a dividend from another company to deduct that dividend from its income and reduce its income tax accordingly.

The amount of DRD that a company may claim depends on its percentage of ownership in the company paying the dividend.There are three tiers of possible deductions. First, the general rule states that the DRD is equal to 70% of the dividend received. Second, if the company receiving the dividend owns more than 20% but less than 80% of the company paying the dividend, the DRD amounts to 80% of the dividend received. Finally, if the company receiving the dividend owns more than 80% of the company paying the dividend, the DRD equates to 100% of the dividend.

The deduction received seeks to alleviate the potential consequences of triple taxation. Triple taxation occurs when the same income is taxed in the hands of the company paying the dividend, then in the hands of the company receiving the dividend, and again when the ultimate shareholder is, in turn, paid a dividend. A taxable income limitation also applies to DRD stipulations. In other words, the DRD cannot create an operating loss for the company.

In the case that the taxable income limitation is met, the DRD equals the percentage (70% or 80% depending on the ownership—as laid out above) of the taxable income. However, the taxable income limitation does not apply if the dividend-receiving company has a net operating loss.

Black Corporation owns 50% of Tan's Corporation common stock and a dividend of $40,000 from Tan. Thus, it would be entitled to a DRD of $32,000, or 80% of $40,000.

Black Corporation has dividend income of $40,000 and is entitled to a dividends received deduction of $32,000.

Tom has dividend income of $40,000, which $40,000 is taxed at the preferential income tax rate.