Slide C3-1
Assignments
For Next Class:
Read Chapter 3, pages 38 – 41
(review previously read pages 1-24)
Problems: C3-58, C3-59, and C3-61
Chapter
3
The Corporate Income Tax
Dividends-Received Deduction
Slide C3-4
Dividends-Received Deduction
Mitigates triple taxation of corporate income
Deduction applies to:
Dividends received by U.S. corporations from other U.S.
Corporations [IRC §243(a)]
Dividend must not be from a corporation that is taxexempt under IRC §501 [IRC §246(a)(1)]
Slide C3-5
Dividends-Received Deduction
Deduction percentages [IRC §243(a) & (c)]
70% DRD if ownership < 20%
80% DRD if 20% < ownership < 80%
100% DRD if 80% < ownership
Slide C3-6
Dividends-Received Deduction
Deduction is limited to a percentage of taxable
income [IRC §246(b)(1)]
70% limit if DRD is 70%
80% limit if DRD is 80%
Unlimited if DRD is 100%
Slide C3-7
Dividends-Received Deduction
[IRC §246(b)(1)] Limitation on DRD is based on
taxable income calculated with:
Charitable contributions deduction allowed
Capital loss carryforwards allowed
But without:
Dividends-received deduction
NOL carrybacks or carryforwards
Capital loss carrybacks
IRC §199 deduction
Slide C3-8
Example 7: Charitable Contributions
The XYZ Corporation has a $55,000 tax net operating loss
carryforward from last year. In addition, the corporation
reported the following income and expenses in its financial
statements for the current year:
Operating income
Dividend income (15% owned companies)
Charitable contributions
Net income before taxes per books
Contributions in excess of 10% limit
$1,800,000
175,000
(300,000)
$1,675,000
$108,000
Slide C3-9
Example 8: DRD
Using the information from Example 7 above,
what is the XYZ Corporation’s dividends-received
deduction and taxable income before the IRC
§199 deduction for the year?
Answer:
 DRD = 175,000 x 70% = $122,500
 Net income before taxes per books
 Add: Nondeductible contributions
 Total
 Limit 70%
$1,675,000
108,000
$1,783,000
$1,248,100
Slide C3-10
Example 8: DRD
Answer:
 Net income before taxes per books
 Add: Nondeductible contributions
 Less: DRD allowed
 Less: NOL carryforward
 Taxable income before IRC §199 deduction
$1,675,000
108,000
(122,500)
(55,000)
$1,605,500
Slide C3-11
Dividends-Received Deduction
Exception to the taxable income limitation: The
taxable income limitation does not apply in years
for which the DRD creates or contributes to a net
operating loss [IRC §246(b)(2)]
Slide C3-12
Example 9: DRD
What amount of DRD and taxable income (before
the IRC §199 deduction) does a C corporation
have in each of the three independent situations
below (the dividends are from companies that are
less than 20% owned)?
(a)
(b)
(c)
Dividend income
$50,000 $50,000 $50,000
Other taxable income 80,000 (10,000) (30,000)
TI before DRD
$130,000 $40,000 $20,000
Slide C3-13
Example 9: DRD
(a)
(b)
(c)
$50,000
80,000
$130,000
$50,000
(10,000)
$40,000
$50,000
(30,000)
$20,000
1. Dividend x 70%
2. TI x 70%
DRD allowed
$35,000
$91,000
$35,000
$35,000
$28,000
$28,000
$35,000
$14,000
$35,000
TI b/f IRC §199
$95,000
$12,000
$(15,000)
Dividend Income
Other Income
TI before DRD
Slide C3-14
Dividends-Received Deduction
Exception:
No DRD is allowed if the stock was held < 46 days
during the 91-day period beginning 45 days before the
ex-dividend date [IRC §246(c)(1)(A)]
Short sales are treated similarly [IRC §246(c)(1)(B)]
Slide C3-15
Example 10: DRD
Purple Corp. purchases 500 shares of White
Corp. on March 18th. White Corp. pays dividends
of $10,000 to Purple Corp. on April 15th (the exdividend date was March 30th). Purple Corp. sold
the 500 shares of White Corp. on April 28th.
45 days before March 30th is February 13th
91 days from February 13th is May 14th
Purple Corp. gets no DRD since the stock was
only held 42 days during the 91 day period
Slide C3-16
Dividends-Received Deduction
Exception:
Dividends received deduction is reduced by the average
indebtedness percentage if the stock portfolio is debt
financed [IRC §246A(a)]
Slide C3-17
Example 11: DRD
The XYZ Corporation received $50,000 in
dividends from U.S. corporations that are less
than 20% owned. The average indebtedness on
the corporations stock portfolio was 63%. What is
the DRD allowed?
Answer: $50,000 x 70% x (1 – 63%) = $12,950
Net Operating Loss Deduction
Slide C3-19
Net Operating Losses
Net operating losses
NOL is the amount by which allowable deductions
exceed taxable gross income [IRC §172(c)]
NOLs are generally carried back 2 years and forward
20 years [IRC §172(b)]
Election to waive carryback and carry forward only
[IRC §172(b)(3)]
 Check the box on Form 1120
 Election is irrevocable
Slide C3-20
Example 12: NOL
A C corporation had the following taxable income and
taxes paid for the first three years of operations:
Year 1 $91,000 ($20,550 in taxes paid)
Year 2 $50,000 ($7,500 in taxes paid)
Year 3 $120,000 ($30,050 in taxes paid)
In the current year (Year 4), the corporation has a NOL of
$(475,000). Taxable income for the next two years (before
any NOL carryforwards) is projected to be:
Year 5 $400,000 ($136,000 in taxes paid)
Year 6 $600,000 ($204,000 in taxes paid)
Assuming an 8% discount rate, should the corporation
elect to waive the NOL carryback?
Slide C3-21
Example 12: NOL
Without election:
TI before NOL
NOL deduction
TI after NOL
Tax before NOL
Tax after NOL
Tax savings
PV Factor
PV of tax savings
NPV of tax savings
Year 2
Year 3
Year 5
$50,000
(50,000)
$120,000
(120,000)
$400,000
(305,000)
$0
$0
$95,000
$7,500
0
$7,500
$30,050
0
$30,050
$136,000
20,550
$115,450
1.000
$7,500
$144,448
1.000
$30,050
0.9259
$106,898
Slide C3-22
Example 12: NOL
With election:
Year 5
Year 6
TI before NOL
NOL deduction
TI after NOL
$400,000
(400,000)
$0
$600,000
(75,000)
$525,000
Tax before NOL
$136,000
$204,000
Tax after NOL
Tax savings
PV Factor
PV of tax savings
0
$136,000
0.9259
$125,926
178,500
$25,500
0.8573
$21,862
NPV of tax savings
$147,788
IRC §199 Deduction
Slide C3-24
U.S Production Activities Deduction
IRC §199 was added October 2004 and is
effective for tax years beginning after 2004
IRC §199(a) allows a deduction equal to a
percentage of the lesser of:
(1) qualified production activities income, or
(2) taxable income before this deduction
The percentages are:
3% for 2005-2006
6% for 2007-2009
9% beginning in 2010
Slide C3-25
U.S Production Activities Deduction
Limitation: U.S. production activities deduction
cannot exceed 50% of the corporation’s W-2
wages for the year [IRC §199(b)]
Slide C3-26
U.S Production Activities Deduction
Qualified production activities income is defined in
IRC §199(c)(1) as:
Domestic production gross receipts [IRC §199(c)(4)]
Less: Allocable cost of goods sold
Less: Other directly allocable deductions
Less: Ratable portion of other deductions