Pat, Maria, and Lynn Are Equal Shareholders in Lime Corporation

Pat, Maria, and Lynn are equal shareholders in Lime Corporation. Lime has assets with a basis of $150,000 and a fair market value of $1,200,000. In the current year, Pat lends Lime Corporation $200,000 and Maria lends it $150,000. Both notes bear interest at the rate of 8% per annum. Lime Corporation has no other debt outstanding. Lynn leases machinery to Lime Corporation for an annual rental of $16,000.

A) The IRS will be successful in reclassifying both loans as equity.
B) The IRS will be successful in reclassifying the $200,000 loan as equity.
C) Lime Corporation cannot support its debt-equity ratio.
D) Because the loans are not pro rata and Lime Corporation can support its debt-equity ratio, the loans should not be reclassified as equity.
E) None of the above.