Let's now apply the key concepts and rules for

the dividends received 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 any areas of confusion.

In this logic check, Illini Inc. forecasts

three levels of gross income for the current tax year,

$10,000, $165,000, and $200,000.

We are asked to determine the dividends received deduction

in each scenario if Illini also receives

$450,000 in dividends from

a 70 percent ownership interest in a US corporation it has held for six years.

We are told to assume $170,000 of Section 162 expenses. So, where do we start?

You will soon learn that determining the starting point is one of

the most challenging components of working through business entity tax issues.

Therefore, I will do my best to always outline

a plan of attack that you can use when I'm not here to guide you.

For this problem, let's begin by calculating the dividends received

deduction in each scenario and then we will worry about the limitation,

an exception you learned about earlier.

In the problem, Illini receives the same amount of dividends in each scenario, $450,000.

Recall that it was forecasting three different levels of gross income, not dividends.

So, we list $450,000 of dividends in each column.

Next, we obtain the applicable DRD percentage from the table presented earlier,

which draws from Section 243A.

The problem noted that Illini has

a 70 percent ownership interest in the dividend paying corporation.

Because the tax year of interest in the problem is after 2017,

this table indicates that for a 70 percent ownership interest,

the corporation receives a 65 percent dividends received deduction percentage.

So, we list 65 percent in each column and then compute the DRD for

each scenario by multiplying dividends received by the DRD percentage.

The result is $292,500 in each case.

Now, recall that the dividends received deduction has a taxable income limitation.

In particular, the DRD cannot exceed the product of the DRD percentage, here,

65 percent, and taxable income computed before deducting the DRD,

NOLs, and capital loss carrybacks.

In other words, this limitation places a ceiling on the total amount of eligible DRD.

Thus, our second step is to check whether this limitation applies in each scenario.

At this point, you might be thinking,

how do I compute the ceiling amount when

gross income rather than taxable income was provided in the problem?

Simple, don't underestimate your tax abilities.

You know how to calculate taxable income using the information provided.

In particular, begin with gross income which was

projected by Illini across the three scenarios,

add dividend income, which was separate from the forecasted gross income,

and then deduct the business expenses.

This process results in three different taxable income amounts across the scenarios.

From here, apply the applicable DRD percentage, 65 percent,

to compute the taxable income limitation of $188,500,

$289,250, and $312,000 in scenarios one,

two, and three respectively.

To recap so far,

we now know the full DRD amount and the taxable income limitation in each scenario.

But recall that the taxable income limitation does not apply if

deducting the full DRD amount would result in a current net operating loss,

that is negative taxable income.

So, step three is to check whether an NOL would occur in such case.

After deducting the full DRD amount computed in

step one from taxable income computed in step two,

we find that deducting the full DRD amount would result in

a negative taxable income that is an NOL only in scenario one.

Taxable income remains positive in scenarios two and three.

We now have all the information necessary to

determine the deduction allowance for each scenario.

Conceptually, the allowable deduction is the full DRD calculated in step

one unless the taxable income limitation computed in step two applies.

But the taxable income limitation does not apply if taking

the full DRD from step one would generate an NOL for the corporation.

Said in another way,

the DRD is the lesser of one,

the full DRD amount, or two,

the taxable income limitation on lesser NOL would

result in which case the full DRD is the allowed deduction.

So, in scenario one,

the full DRD of $292,500 exceeds the taxable income limitation of

$188,500 indicating that the DRD is limited to $188,500.

But in this scenario,

taking the full DRD would result in an NOL,

meaning the taxable income limitation does not apply.

Thus, the allowable DRD is the full amount of $292,500 in scenario one.

In scenario two, the full DRD of $292,500 exceeds the taxable income limitation of

$289,250 indicating that the DRD is limited to $289,250.

In this scenario, taking the full DRD would not generate an NOL.

Thus, the taxable income limitation does indeed apply.

Consequently, the allowable DRD in scenario two is $289,250.

Finally, in scenario three,

the full DRD of $292,500 does not exceed the taxable income limitation of $312,000.

Thus, the corporation is entitled to the full DRD of $292,500.

Keep in mind that the limitation is a ceiling that the DRD cannot exceed.

It is not the deduction amount if the full DRD is smaller.

Overall, the DRD might be slightly confusing at first but with a little practice,

you'll find it makes some sense.