Malcomb and Sandra (shareholders) each loan Crow Corporation $50,000 at the market rate of 6% interest. Which of the following statements are false?
A)Crow may deduct the interest expense, and the interest income is taxable to Malcomb and Sandra.
B)When the note principal is repaid, neither Malcomb nor Sandra recognizes gross income from the repayment.
C)If the IRS were successful in reclassifying the notes as equity, the interest payments would not be deductible by Crow, and Malcomb and Sandra would still recognize income.
D)If the IRS were successful in reclassifying the notes as equity, repayment of the note principal to Malcomb and Sandra would not qualify for return of capital treatment and would most likely result in dividend income treatment for Malcomb and Sandra.
E)All of the above are true.

Question

Quizplus · Accepted Answer

All of the statements are true. Interest expense is deductible for Crow, and the interest income received by Malcomb and Sandra is taxable. When the principal is repaid, there is no recognition of gross income for either party. If the IRS reclassifies the notes as equity, the interest payments will not be deductible by Crow, and Malcomb and Sandra will still recognize income. If the notes are deemed equity, repayment of the principal will result in dividend income treatment for Malcomb and Sandra, as it will no longer qualify for return of capital treatment.

Malcomb and Sandra (Shareholders) Each Loan Crow Corporation $50,000 at the Market