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Let's now apply the key concepts and rules for

the the dividends receipt deduction to an actual, but simple scenario.

Throughout the course, I will refer to these applications as logic checks.

The goal, of course is to check whether or

not you comprehend the logic of the lesson.

If not, revisiting the lesson should help alleviate areas of confusion.

So in this question, Illini, Inc forecasts three levels of gross income for

the current tax year.

$75,000, $165,000 and $200,000.

And we want to know what is the dividends received deduction in each scenario,

if Illini receives $450,000 in dividends from a 70% ownership interest and

a US corporation it has held for six years?

And we're also told to assume $170,000 of section 162 expenses,

which you may recall are the ordinary necessary expenses or

basically regular deductions for corporations.

So where do we begin?

We're going to begin by calculating the dividends received deduction and

then in separate steps will apply the two limitations, and

other exceptions that we learned about a few minutes ago in the concepts.

So let's begin by looking at each scenario where we're

told to assume $450,000 of actual dividends.

So we write $450,000 down three separate times.

And now, we're going to apply our dividends received deduction

percentage which if you recall from the concepts discussion,

the amount that we're allowed to use depends on how many shares or

the percentage of shares that is owned by the corporation.

And in this case, we're told in the problem that we have a 70% ownership

interest in a US corporation.

And here, we see from the table that when that applies,

that we actually have an 80% dividends received deduction.

So in other words, that's the the amount we're going to use to calculate

the dividends received deduction in this situation.

So across each of our three scenarios, we'll write down 80% in each column.

So 80, 80 and 80.

And now, we can calculate the base dividends received deduction

by multiplying $450,000 times 80% in each scenario.

So we'll get $360,000 In each of the three columns.

So this is the basic dividends received deduction amount.

But as you recall from the concepts discussion,

we have to check a potential taxable income limitation.

In other words, there's a ceiling with which we cannot exceed.

So how do we calculate that,

given that taxable income was not given in the problem?

Well, as you might expect, we need to figure out what taxable income is and

we have all the necessary components to do that.

So let's start with gross income just like we would from an introductory tax course

to calculate taxable income and then we'll add in some other income,

as well as expenses.

And so we were told that there were three separate scenarios that Illini was

forecasting its levels of gross income for the current tax year.

So let's write that down in each of the three scenarios across the board.

So in the first scenario, we have $75,000 of gross income.

The second one, we had $165,000 gross income and we had $200,000 of gross

income and just to show you to make sure you understand recall from the problem

these were the numbers that were given to us in the problem itself.

So this is where these guys are coming from here.

So now that we have that,

we can add in the dividends which we are told are 450,000 in all 3 scenarios.

So we'll add these in and now we have all of our income represented.

And then finally,

we'll subtract any amount of deduction that we have this year.

And we were told to assume 100, I'm sorry,

$175,000 of section 162 expenses in each of the 3 scenarios.

So we'll subtract 170,000 in each column.

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And so if we sum these up,

we can get taxable income in each of the three scenarios.

And so we get 355,000 in the first.

445,000 in the second and 480,000 in the third scenario.

And so the rule says that the amount of the dividends received deduction that we

compute cannot exceed a taxable income limitation,

which is what we're checking now.

And that limitation is computed as the dividends received deduction percentage

times taxable income before the dividends receive deduction,

then operating losses and any capital loss carry forwards as well as the domestic

production activities deduction.

So we don't have any of these other things in this scenario.

So we're going to take our dividends received deduction percentage that we used

earlier, the 80% from step one and multiply it by taxable income.

So we'll multiply each of these three taxable income numbers for each scenario

by the 80% amount and then that's going to give us our taxable income limitation.

Another way to think about it,

that's going to give us our ceiling which can kick in and

stop us from recognizing anymore than this in the dividends received deduction.

So we get 284,000 in the first scenario,

356,000 in scenario two and then 384,000 in scenario three.

But we're still not done yet, now we have to check for a net operating loss.

Because recall that the limit, the taxable income limitation does not apply if

the corporation has a net operating loss after deducting the full amount of

the dividend's received deduction.

So let's go to our taxable income numbers and

then apply the full dividends received deduction to see if we have taken the full

amount that it would result in a net operating loss.

So let's start with taxable income that we computed in step two.

So we have 355,000 in scenario 1, this is from step 2.

445,000 in scenario 2 and 480,000 in scenario 3.

And we're just going to see what would happen if we deducted the full

dividends received from step one of $360,000 in all three scenarios?

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And so when we apply that, we see that there is a $5,000 net operating loss or

negative net income is another way to think about it in scenario one.

We would have a positive amount of 85,000 in scenario 2 and

a positive amount of 120,000 in scenario 3.

So if we put all this together,

we can now answer the question which is what is the dividend's received deduction

in each of these scenarios by applying the basic rules here.

So as a first step,

it should be the dividends received deduction from step one.

But we're only entitled to the amount that does not exceed the taxable income

limitation, which we computed in step two.

However, that limitation does not actually apply to us if taking the full amount from

step one would actually generate negative taxable income or a net operating loss.

So lets look at that for each scenario.

So starting in scenario one, we calculate $360,000 of dividends received deduction.

Our limitation in step 2 says that we can't exceed $284,000, but that limitation

does not apply if taking the full 360,000 would result in negative net income or in

NOL and we see in step 3 that it actually would result in a negative net income.

So the limitation does not apply.

So for scenario one, the amount that we can actually take as a dividends received

deduction is $360,000, the full amount.

Now in scenario two, we apply the same logic.

So we start with our $360,000 dividends received deduction and

we're told we cannot exceed the taxable income limitation of $356,000,

which we did go over.

So that would be our cap or ceiling,

unless it generated an NOL which it does not.

Because we have $85,000 in positive net income in step three.

So our answer for scenario two would be the $356,000.

And then finally in scenario three,

we have the same $360,000 full dividends received deduction.

Our ceiling is 384, the taxable income limitation which we do not exceed, so

it does not bind against us.

And we have no concern about an NOL which it doesn't generate one, anyway.

So our result or our answer for scenario three would also be the $360,000.

So across the board, we have 360,000 in scenario 1.

356,000 in scenario 2 and $360,000 in scenario 3.

So hopefully,

this help clear up a little bit about the dividends received deduction.