Stock in Jaybird Corporation (555 Industry Lane, Pueblo, CO 81001) is held equally by Vera, Wade, and Wes. Jaybird seeks additional capital in the amount of $900,000 to construct a building. Vera, Wade, and Wes each propose to lend Jaybird Corporation $300,000, taking from Jaybird a $300,000 four-year note with interest payable annually at two points below the prime rate. Jaybird Corporation has current taxable income of $2 million. You represent Jaybird Corporation.
Jaybird's president, Steve Ferguson, asks you how the payments on the notes might be treated for tax purposes. Prepare a letter to Ferguson and a memo for your tax files in which you document your conclusions.