Thomas transfers cash of $160,000 to Grouse Corporation, a newly formed corporation, for 100% of the stock in Grouse worth $90,000 and debt in the amount of $70,000, payable in equal annual installments of $7,000 plus interest at the rate of 5% per annum. In the first year of operation, Grouse has net taxable income of $40,000. If Grouse pays Thomas interest of $3,500 and $7,000 principal payment on the note:

Question

Quizplus · Accepted Answer

Thomas transferred cash of $160,000 to Grouse Corporation for 100% of the stock in Grouse, worth $90,000, and debt of $70,000, payable in equal annual installments of $7,000 plus interest at the rate of 5% per annum. In the first year of operation, Grouse has net taxable income of $40,000, pays interest of $3,500, and makes a principal payment of $7,000 on the note.
Since Grouse paid $3,500 in interest to Thomas, Thomas should report it as interest income on his personal tax return. Grouse can deduct the $3,500 as an interest expense on their corporate tax return. Therefore, Choice C is correct. 
Neither A, B, nor D are correct because Thomas does not receive a dividend from Grouse in this scenario.

Thomas Transfers Cash of $160,000 to Grouse Corporation, a Newly