Similar to dividend exclusion, the dividend received deduction allows companies to avoid paying taxes on the dividends they receive from their investments.
Some stocks pay out dividends, or an amount of cash for each share held. You buy 1,000 shares of Fat Payments Inc. at $50 a share. The stock pays out a $0.50 dividend per share each quarter. So once every three months, you get $500: $0.50 times the 1,000 shares you own. If a company owns Fat Payments stock, they might be in line for the dividends received deduction (which applies only to corporations). So when Mass Conglomerate Ventures Corp. buys 1,000,000 shares of Fat Payments and gets $500,000 a quarter in dividends, it can get a tax break on some of that cash.
The goal here is to avoid taxing the dividend multiple times. In this case, it avoids the dreaded triple taxation, turning dollars of profit into a quarter and change.
You also own shares of Mass Conglomerate Ventures Corp., which also pays its own dividend. If the dividend was taxed when it passed from Fat Payments to Mass Conglomerate, that money would ultimately get taxed three times. Once when Fat Payments earned the cash in the first place. Again when it paid the dividend to Mass Conglomerate. And eventually a third time when Mass Conglomerate paid out a dividend to you.
Related or Semi-related Video
Finance: What is a Dividend?1777 Views
Finance a la shmoop what is a dividend? well let's start with how [Bird flying with a bag]
dividends came to be well dividends are the result of a great and awesome quote
problem unquote.. what happened to corporations is they grew and became
dominant in their respective industries they retained so much cash profit even [man as a giant corporation crushing city buildings]
after building factories digging mines and smelting whatever they smelted well
that they couldn't figure out what to do with the cash so under a lot of [man with an open briefcase full of cash]
shareholder pressure and that is the common shareholders would threaten to
fire the Board of Directors, the fat and cash happy corporations just to begin to [common shareholders hitting the board of directors]
give it back to shareholders their owners who were in turn made happy by
that event and in many cases on the announcement of an increased dividend [share prices increasing and man shouts into a speaker]
policy share prices went up because of that whole investor happiness thing
there's a good structural reason for dividends to exist however they force [men bricklaying]
companies to be disciplined in their spending that is if companies aren't
disciplined, they don't have the money to pay the dividend and well when that
happens to a company basically everyone gets fired in most public companies [Donald Trump firing an employee]
dividends are viewed as a long-term commitment not as like a one-time thing
in fact during the Great Depression AT&T famously continued paying its dividend
without fail and many families relied on that dividend to make ends meet in the [family together eating dinner]
modern era companies in financial stress have even borrowed money just to make
sure they can pay their dividends to investors why well they believe that
when they get through the tough times they'll return to that massive [man running down a road sign posted under tough times]
profitability and they'll have a track record of continuing to pay dividends [oil machine working as cash piles up]
and that love is worth taking out a loan to pay a dividend the other big thing to
consider is that dividends are a very meaningful part of investment returns [dividends arrow pointing to investment returns]
which lousy financial journalists so often seem to forget many will decry the
era of the 70s as a lost decade looks like the stock market went nowhere from [man fumbling through a skip]
1968 to about 1980 right? well no it didn't go up but during that
period company's continued to pay their dividends and for the decade the [money going into a shareholders window]
dividend rate of the average S&P 500 company was about six percent so if
you've done nothing other than collect your six percent a year in dividends [Man collecting a 6% dividends]
well you would have been just fine you would have almost doubled your
investment money this way ignoring taxes from about nineteen sixty eight to [Man doubling his investment money from 1968-1980]
nineteen eighty and that's not bad for a lost decade
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