 Hello and welcome to this session in which we'll discuss the concept of dividend received deduction, known as D or D. What is the big idea of dividend received deduction? It's to avoid the multiple taxation of dividend. What does that mean exactly? Well, let's assume we have a company A. A company A operates, they generate revenue, they incur expenses and as a result, they have a net income, more revenues than expenses. What's going to happen to that net income? Hello and welcome to this session in which we will discuss the dividend received deduction. What is the dividend received deduction? It's a deduction given by the IRS to receivers of dividend. Why? For what purpose? Well, to avoid the multiple taxation of dividend. What does that mean exactly? Well, let's take a look with a simple example to illustrate the concept of multiple taxation of dividend. Let's assume we have company A, company A generate revenue and incur expenses. As a result, they have a net income, more revenues than expenses. What do companies do when they have net income first? They close this account to retained earnings and eventually they might pay out dividend. So that's fine. Now, sometime what they do is they pay out dividend to other corporation that owns company A. So we might have company B and since company B is an owner in company A, company B will be receiving dividend that is previously taxed in company A. So company B would receive this dividend and they would include this dividend with their revenue. Again, we're dealing with a C corporation, then they reduce their expenses, then they will get to net income. Then what do they do with that net income? They put it in retained earnings first, then they might pay out dividend. Then company B might be owned or some of their shares by company C. Well, if they pay dividend, this dividend goes to the revenue of company C. Company C will incur expenses, they will have net income, that net income would sit in retained earnings, it will pay out dividend. So I hope you're starting to see the point that it's the same dividend that company A generated that paid out to company B was taxed first for company A because company A paid their taxes first, then that same dividend was transferred to company B. Company B paid taxes on it, then paid some of it to company C and company C paid taxes on it. So notice the same income would just transfer from company A to company B to company C and it's being taxed multiple times. So if a corporation owns a stock and another corporation will receive a dividend, a portion of that dividend may be deducted from income. So the government says, okay, this looks a little bit unfair, what we're gonna do, okay, you're gonna include this dividend in revenue, we are going to give you part of your expenses. A phantom, phantom means like a deduction that don't exist, it's called dividend to receive a deduction. So we're gonna give you a deduction if you own stocks in another company. Well, how much the deduction is going to be? Well, depending on your level of ownership. So if you own less than 20% of a company, you will get a dividend received deduction of 50%. If you own between 20 to less than 80 will give you 65. Once you own more than 80% of a company and they pay you dividend, you will get a full 100% dividend to receive the deduction. So if you received $100 in dividend, you have a dividend to receive deduction of $100 assuming you own more than 80% of company A. Why? Because company A already paid taxes on that income. Why would I as an owner pay taxes on income that I technically own because I own 80% of the company? So that's the big idea. Now the dividend to receive deduction is limited to a percentage of taxable income. There's always a limitation and that percentage is the same as the deduction percentage means the same as the ownership deduction percentage. So what is the limitation of the DRD? Let's talk a little bit more about the limitation. Before we proceed any further, I have a public announcement about my company farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true false questions, as well as exercises. Go ahead, start your free trial today. The dividend to receive deduction is limited to the lesser of a percentage of dividend to receive deduction and that percentage, depending on what percentage it is, it could be 50% if you own 20% or less. It could be 65 if you own 20 to 80 and obviously it will be 100% if you own more than 80% or 50 or 60% not 50 or 65% of the taxable income corresponding to the percentage. What does that mean exactly? It means we're going to have to compute taxable income and take 50% of taxable income. We're going to see how we compute taxable income, take 50% of the dividend to receive, compare those two to each other. Now when we compute this amount of taxable income and dividend to receive deduction, we have to ignore those limitations if the DRD creates an NOL, too many acronyms. Here's what we're going to do. We're going to first compute the dividend times a percentage and we're going to get a number. We're going to take the taxable income times the same percentage, whatever that percentage is, either 50, 60 or if it's 100%, 100%, get a number. Now once we get to the DRD number, the first number, we're going to take the DRD and deduct it from taxable income. If the DRD minus taxable income gives us an NOL, that's it, we'll go with the DRD, we'll go with the 50% of the dividend. If not, we have to take the lesser of 1 and 2. Don't worry, we're going to work an example. So if an NOL exists, then the NOL rules take priority over the limitation, which is the percentage times the dividend. And bear in mind, any unused DRD is lost. You can use it or lose it. Basically, this is how it works. And for the purpose of the taxable income, because remember, we're going to have to take a percentage times the taxable income, we're going to ignore any NOL deduction. So this taxable income is computed before net operating loss deduction, if we have an NOL deduction, any domestic production activity deduction, we don't take this deduction into account. Obviously, we would ignore the DRD deduction because we are doing this computation to arrive to our DRD and any capital loss carry back for the current tax year. Now let's first look at the steps involved in computing the DRD, then we'll work an example. Step one, you'll take the dividend that you receive times a percentage. What's that percentage? It could be 50, it could be 65, or it could be 100%. If that's the case, forget it, you put the dividend, then you take it out. Then step two, multiply taxable income by the deduction percentage, same in one. So if you multiply it by 50%, you multiply taxable income by 50%. Now, oftentimes taxable income will be given to you. If not, you have to make sure taxable income is computed without regard to those four items. Then what you do next, here's what you do next. Before you proceed any further, you would say, okay, I'm going to take, I'm going to subtract whatever I got in step one from taxable income. Whatever I got in step one, subtract it from taxable income. If I get, as a result of deducting this amount, I got an NOL, not operating loss. That's it, I'm done. I will choose number one. If the DRD does not create or increase in already NOL, well, then I will choose between one and two. That's too many steps, right? What is this? Let's work a few examples illustrating this point. I'm going to move to the Excel sheet and show you several scenarios illustrating the simple concept that you need to know, powerful simple concept, and it's easy points on the CPA exam, enrolled agents exam, as well as your accounting course. So let's take a look at those three scenarios. We have Adam, Noah, and Farhat, three different corporations. The gross income for Adam is $520,000, expenses from operation $360,000. The company received $200,000 in dividend, and the payer is owned 20% by Adam. So Adam owns 20% of the company that paid Adam $200,000. And taxable income before the DRD is $360,000. So they're giving us taxable income before the DRD. How do we come up with the taxable income before the DRD? We took gross income, $520,000 minus the $360,000 plus the $200,000. So the taxable income before the DRD, before the deduction is $360,000. Because we have a gross income, let's let me show it to you another way. We have a gross income of $520,000. We have dividend from that company that we own $720,000. So total income is $700,000, $200,000, $720,000 in total. Then we have $360,000 in operating expenses. Therefore, our taxable income before the DRD is $360,000. What do we do next? Immediately, what we do before we proceed any further, this will make our life easier. If we'll take 50% of the dividend, we compute step one, it's $100,000. Then we say, okay, let's take taxable income before the DRD minus the DRD. So if we take taxable income before the DRD, $360,000 minus the potential DRD deduction, $100,000, it gives us $260,000. Did this create an NOL for us after we did the deduction? And the answer is no, we don't have an NOL. If we don't have an NOL, what's going to happen is we're going to choose between step one, which is 50% of the dividend, and step two, which is 50% of taxable income. 50% of taxable income is 360, which is 360 times 50%. Which one are we going to take now? The lesser of step one or step two. The lesser of step one and step two is $100,000. That's fine. Now, let's take a look at NOAA company. NOAA company, they have gross income of $340,000. They receive dividend of $200,000. They have total revenue under W20, $540,000. Then they're going to deduct $360,000 in operating expenses. They're going to come up with $180,000. So let me just double check the math. $540,000 minus $360,000, that's $180,000. That's good. So we arrived to taxable income before the R&D. We're going to take the dividend times the 50% percentage, because we own 20% of the company. That's $100,000. Before we proceed any further, we're going to take $180,000 minus $100,000. $180,000 minus $100,000 equal to 80%. Did it create an NOL? No. If that's the case, then we're going to go to step two. What's a step two? Step two, take 50% of taxable income. 50% of $180,000 is $90,000. Now, we compare $90,000 to $100,000, and the DRD is the lower of these two. The lower between $90,000 and $100,000 is $90,000. Therefore, our DRD is $90,000. Let's take a look at scenario three, Fahad, Fahad company. Gross income, $250,000. We have $200,000 of dividend. That's $450,000. Then we're going to have operating expenses of $360,000. That's going to give us taxable income before the R&D of $90,000. Then we're going to do what? We're going to go ahead, take the dividend, multiply it by 50%. We have $200,000 of dividend, multiply it by 50%. Now, if we take taxable income before the R&D minus the potential of the R&D will give us $10,000. It's going to put us into a net operating loss. Excellent. Once we are in a net operating loss, drop all the rules. You no longer have to go through step two. Basically, you will take 50% of the DRD, and we deduct $100,000. Notice I gave you three scenarios. One were no NOL, and step one, which is 50% of the R&D was lower than the taxable income. In scenario two, no NOL, and the 50% of taxable income was lower than the 50% of the dividend. In scenario three, we have an NOL scenario, well, easy percentage times the dividend. Now, for tax planning purposes, we have to understand that for tax planning, it's very important for companies to understand this deduction, because it could make a difference to their bottom line. Let me show you this scenario. Let's assume we have a company with a gross income of $205, expenses from operation of $250,000, and dividend received from domestic corporation $100,000. So $205,000 minus, sorry, plus $100,000 first. Let's include the dividend. That's total revenue of $305,000. Then we subtract the dividend, $250,000. We come up with $55,000. So this is taxable income before the R&D. Now, 50% of dividend is $50,000. I'm sorry, 50% of $100,000. We have $100,000 in dividend for the sake of illustration in this company. Therefore, $50,000. Now, if we take $55,000 minus $50,000, we'll give us $5,000. Is this an NOL? And the answer is no. If it's not an NOL, you have to go through step two and find the difference between the two. And let's go ahead for this purpose. Just find the difference between the two to show you what's going to happen if that's the case. So we'll take $55,000 now times 0.5, and that's going to give us for step two, $27,500. Now, we compare $50,000 to $27,500. And which one do we take? We'll take $27,500 as a DRD for this company. Let's stop for a moment here and think about the computation here. From a tax planning perspective, what can we do as a company? Here's what we can do as a company. We can do one of two things. We can either defer some revenue, somehow if we can defer some revenue. And since creating NOL is $5,000, if we can defer $5,000 and a dollar of revenues, we can defer. Notice I am what I'm doing is I am deducting from my revenue, my revenue right now, my gross income is 205, I am deferring $5,000 and a dollar. So somehow if I can defer this, okay, I'm going to create an NOL. Once I create an NOL, I can take the full $50,000. Or if I cannot defer $5,000, if I cannot defer $5,000 and a dollar of revenues, can I somehow increase my operating expenses by $5,000 and a dollar? If I can do that, I also would create an NOL as a result of my computation. Therefore, I don't have to take the $27,500, I can take the $50,000. So notice what happened here. If you can plan properly and either move revenue or income down the road or accelerate some expenses enough to make you create an NOL, then you can take the 50% times the dividend. So I hope this helps in terms of computation. How do we perform the computation? I gave you different scenarios. Let's go back to the PowerPoint slides. What else do we have to know about the dividend received deduction? There's a 45 days holding period. What is that? What is that rule? To prevent tax loopholes related to short-term stock holding, a restriction was implemented stating that no dividend received deduction is permitted unless the corporation holds the stock for more than 45 days. So to be able to get this dividend received deduction, you have to buy the stock, hold it at least for 45 days in order to qualify for the dividend received deduction. Why? Because they don't want you to buy the stock, sell it, basically trading stocks and get the deduction. That's not the purpose of the deduction. This rule addresses a situation where the stock is purchased shortly before a dividend record date. So you get the dividend and what's the record date? So you have to own the stock on that date. You would buy a little before the dividend record date. So you will be on record. Then you sell it X dividend. What's X dividend? After you receive the dividend, you qualify for the dividend, you sell it. So you bought it only for the purpose of receiving the dividend. And sometime it could result in a capital loss equivalent to the dividend amount. So you could also, even though you might incur a loss, we don't care. You don't care. Why? Because you're going to get a dividend received deduction. And we're going to work an example with numbers. If dividend received deduction were allowed in such cases, the capital loss resulting from the stock sale would exceed the taxable portion of the corresponding dividend. So what happened is the loss would offset the dividend. So what did they try to do? You have to hold the stock for 45 days at least. Let's work an example and see what we are talking about here. October 2nd, Adam Corporation declares a dividend of $1 per share for shareholder recorded as of November 1st. So on October 2nd, they said we're going to pay dividend $1 per share. You have to own the stock November 1st. The dividend is scheduled to be paid in December 2nd. So let me just show you on a timeline. This is October 2nd. So this is where they declared it. So we're going to pay dividend. And they say in order to get the dividend, you have to own the stock November 1st. This is the record date. So you have to own the stock on that date. And we're going to pay you in December, December 2nd. So as long as you own the stock here, you're going to get the payment. Okay. So here's what happened. NOAA Corporation purchased 10,000 shares on October 29th. So notice October 29th is before December, November 1st. So what they did, they bought it before the record date. So on November 1st, they're on record as owners. Okay. Well, as a result, they're going to get the payment. So that's what they did. Subsequently, a few days later, November 7th, NOAA sells the 10,000 shares for $20,000. So they bought it for $30,000, sold it for $20,000, they incurred the loss of $10,000. Okay. Assuming no market price fluctuation except for the dividend component. Now we're assuming here because it's ex-dividend, the stock went down, but the stock could go down further, could go up, but we're going to assume that they incurred the loss for $10,000 and they created a short-term capital loss. You know, they paid 20 basis, they received, I'm sorry, they paid 30, they received 20. So that's one thing they have a long short-term capital loss. What can they do with the short-term capital loss? For corporation, it doesn't matter whether it's short-term or long-term, it's simply put a capital loss. If they have capital gains, they can offset some capital gains. Okay. Also on December 2nd, NOAA received $10,000 in dividend. Remember they were owner as of the record state. So they got here $10,000 of dividend. Okay. So notice every, if all said and done, they lost 10,000, they gained 10,000. Do you see this? So it's like, basically you would say, well, why would you do this? You're basically the net is zero. Well, not really. Now, if they received for the dividend received deduction, if they got the dividend received deduction, if they get the dividend received deduction, they're going to get a $5,000 deduction because they own, we're going to assume they own less than 20% of Adam company. Well, what's going to happen is they're going to receive an additional $5,000 in dividend received deduction. Well, that's good. So they received $5,000 in the deduction. That's basically what they did. So if the holding period restriction did not exist, NOAA corporation would be eligible for 10,000 capital loss, again, subject to capital loss limitation, assuming they can use it. However, the income would only be $5,000. Why? Because the dividend is 10, then they get a dividend received deduction of $5,000. So here's what's going to happen. A loss of $15,000, a dividend of $10,000, assuming they can and a dividend received deduction of $5,000. So notice all in all, they were able to get a $5,000 deduction, if this makes sense or not. So they lost on the game. This is a real loss. They lost, they bought it for 30, sold it for 20. This is a real dividend. And this is a deduction given by the government DRD. As a result of this DRD, they get a deduction for $5,000 for doing something like this. So what did the government says? Guess what? When it comes to dividend received deduction, you have to own the stock for 45 days because after 45 days, you know, market could change. I mean, you could still experience a loss, a phantom loss from the DRD, but at least give it 45 days. You just, so you're not doing it for the short term. So this is what you need to know for DRD. Now, am I gonna, should I work an example illustrating more DRD computation? I think I should work an example doing so. But what should you do now? Whether you are a CPA candidate, enrolled agent or an accounting student, go to Farhat Lectures, look at additional lectures, MCQs, true-false, and I'm gonna work more examples. Good luck, study hard, and of course, stay safe and stay motivated.