L and R Each Received $500,000 from Their Mother to Start

question 35

Multiple Choice

L and R each received $500,000 from their mother to start their own businesses.L transferred her $500,000 to her corporation for shares of stock worth $200,000 and a $300,000 note bearing 10 percent interest.The interest is payable in annual installments of $30,000 for 15 years.In contrast, R contributed his $500,000 to his corporation in exchange solely for stock.Assume both corporations are equally successful and have current EP (earnings and profits) exceeding $30,000 at the end of their first year.During the year, L receives an annual principal payment of $25,000.To acquire $25,000, R redeems stock of his corporation worth $25,000.Which of the following statements is true?

• A)L's principal payment is tax-free.
• B)L's debt could be reclassified as stock if the corporation were too thinly capitalized.
• C)R's $25,000 will be taxed as a dividend.
• D)All of the above

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