Exercise 5-21 (LO. 6)

Deerwood Corporation lends its principal shareholder, Lafayette, $500,000 on July 1 of the current year. The loan is interest-free and payable on demand. On December 31, the imputed interest rules are applied. Assume that the Federal rate is 3%, compounded semiannually.

What are the tax consequences of this loan?

Lafayette has

interest income dividend incomea return of capital

of $fill in the blank 2 and Deerwood has

a dividend payable interest expense interest income

of $fill in the blank 4.