How are dividends received by corporations treated for tax purposes?

Dividends received by corporations are generally subject to specific tax treatment which allows for a dividends received deduction. This deduction is designed to mitigate the issue of double taxation that occurs when income is distributed as dividends. Essentially, when one corporation receives dividends from another, it can deduct a portion of those dividends from its taxable income, depending on several factors, primarily involving the ownership percentage in the distributing corporation.

This deduction typically allows the receiving corporation to exclude a significant amount of the dividends from its taxable income. For example, if the receiving corporation owns less than 20% of the distributing corporation, the deduction is generally 50% of the dividends received. If the ownership is between 20% and 80%, the deduction increases to 65%. If the corporation owns more than 80%, the dividends may not be taxable at all for the purposes of corporate tax.

Understanding how this deduction works is crucial for corporations to effectively plan their tax strategies and minimize overall tax liability. This treatment contrasts with dividends received being taxed at a flat rate or treated as ordinary business income, which do not provide the same relief from double taxation.