A owns half the common stock of X with an adjusted basis of $40, and Y owns the other half of the X common stock with an adjusted basis of $100. Xs current E&P from current-year income and expenses/losses is $94, and X has no accumulated E&P. X uses the accrual method, all taxpayers are on the calendar year, and 1059 does not apply. Assume that the corporate tax rate is 34 percent.

Assume for this problem that beginning E&P is $100, rather than $94. X issues and distributes two negotiable notes payable by X to A and Y (each note having a face amount and stated principal amount and stated redemption price at maturity of $120 and FMV of $100). What would result now, during the terms of the notes, and upon collection? First, ignore 01]), market discount, and the time-value-of-money rules generally.