George transfers cash of $150,000 to Grouse Corporation,a newly formed corporation,for 100% of the stock in Grouse worth $80,000 and debt in the amount of $70,000,payable in equal annual installments of $7,000 plus interest at the rate of 9% per annum.In the first year of operation,Grouse has net taxable income of $40,000.If Grouse pays George interest of $6,300 and $7,000 principal payment on the note:

Question

Quizplus · Accepted Answer

George transferred $150,000 to Grouse Corporation in exchange for 100% stock and debt of $70,000. Therefore, the stock received has a basis of $80,000, and the debt has a basis of $70,000.

In the first year of operation, Grouse Corporation has $40,000 of net taxable income, and it pays interest of $6,300 and principal payment of $7,000 on the note to George.

As for George's tax consequences, the interest payment of $6,300 is treated as taxable interest income. The principal payment of $7,000 reduces the outstanding debt, but it does not create taxable income for George. Therefore, George has a total of $6,300 of taxable interest income.

As for Grouse Corporation's tax consequences, the interest payment of $6,300 is deductible as interest expense, and the principal payment of $7,000 is not deductible. Therefore, Grouse Corporation has a $6,300 interest expense deduction.

Hence, the correct answer is D.

George Transfers Cash of $150,000 to Grouse Corporation,a Newly Formed