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?

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All the statements are true. L's principal payment is tax-free because it is a return of capital. L's debt could be reclassified as stock if the corporation is too thinly capitalized, which is a concern when debt is used to finance the corporation instead of equity. R's $25,000 will be taxed as a dividend because it is a distribution of the corporation's earnings and profits.

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