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

Quizplus · Accepted Answer

If the IRS reclassifies some of the debt as equity, the interest paid on that reclassified amount is treated as a dividend. This means that Mr. Eddy will receive dividend income instead of interest income, and the corporation may not be able to deduct the dividend payments as a business expense. The reclassification could also impact the corporation's debt-to-equity ratio and overall financials, potentially affecting its ability to secure future loans or investments. The taxable income of the corporation and Mr. Eddy may also be affected by the reclassification, but it is not necessarily true that it will increase or stay the same without additional information about their specific tax situations.

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