Mr. Eddy loaned his solely-owned corporation $3,000,000. The corporation paid a market rate of interest annually. Upon audit, the IRS reclassified some of the debt as equity. Which of the following statements is true?

Question

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When debt is reclassified as equity, the interest paid on that amount is treated as a dividend instead of interest expense. Therefore, statement A is true. Statement B is false because the reclassification of debt to equity may affect the taxable income of the corporation. Statement C is also false as Mr. Eddy's taxable income would not be directly affected by the reclassification, though it may have an indirect impact on his personal income if the corporation's profits are distributed to him as a shareholder.

Mr Eddy Loaned His Solely-Owned Corporation $3,000,000