25. LO.5 Parrott, Inc., a C corporation, is owned by Alfonso (60%) and Deanna (40%).

Alfonso is the president, and Deanna is the vice president for sales. Parrott, Alfonso, and Deanna are cash basis taxpayers. Parrott encounters working capital difficulties, so Alfonso loans the corporation $810,000, and Deanna loans the corporation

$540,000. Each loan uses a 5% note that is due in five years with interest payable annually. Determine the tax consequences to Parrott, Alfonso, and Deanna if:

a. The notes are classified as debt.

b. The notes are classified as equity.