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 the Dividend Discount M...2 Views
Finance allah shmoop what is the dividend discount model Well
it's a technique used to value companies or at least
it wass in the stone age And yet in the
nineteen fifties maybe which basically says that a company's value
is fully contained in the cash dividends it distributes back
to invest doors This model is only useful really for
its historical relevance We we just don't use that much
these days Yeah back in the old timey cave man
days when there was essentially no research of real merit
being done on the performance of investments of whatever flavor
the dividend discount model was the best thing investors had
to value an investment in a company And remember in
those days companies paid rial dividends that were a meaningful
percentage of the total value of the company Unless so
a company pays a dollar a share this year in
dividends Historically it's raised dividends at about three percent a
year like paid a dollar last you'd expect two dollars
three next year in dollars six and change the next
so well The dividend discount model discounts backto present value
And yes we have an opus on what president value
Means but here's the logline definition present value of all
future cash flows discounted for risk in time Back to
cars Yeah that thing well a few odd things are
worth noting in this horse and buggy era formula The
dividend discount model ignores the terminal or end value of
the company Like say twenty years from now the company
is sold for cash The dividends are all that are
really focused on though in our model that seem strange
to you Well maybe But let's say the discount rate
is ten percent in the risk free rate is four
percent for a total of fourteen percent a year discounted
back to the present So doing the math just looking
at the terminal value of say a hundred million bucks
in a sale to be made twenty years from now
Let's figure out what that's worth today Well you take
the one point one four Put it to the twentieth
power to reflect twenty years of discounted valuation compounding And
you say one point one four forty twenty powers about
thirteen point seven So to get the present value of
one hundred million bucks twenty years from now using this
discount rate Will you divide the hundred million by thirteen
point seven and that means that the one hundred million
dollars twenty years from now today is worth only seven
point three million bucks And yeah that's ah big haircut
kind of like this guy Well the formula focuses ah
lot on near term dividend distribution and it's Really more
interesting is a relic of original financial research in theory
than anything directly useful today And if you find this
interesting while then we may have a gig for you
here at shmoop finance central Yeah come on down We 00:02:39.715 --> [endTime] need writers good ones not like me
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