The same issue outlined in the original post is still occurring as of today, April 30th, 2022.
Steps to replicate issue:
Set up certificate signing in Xcode.
Connect iPhone via USB cable into Mac.
Unlock iPhone.
Build & run for iOS only.
Xcode will hang indefinitely on step: "iPhone is busy: Preparing Apple Watch for development via iPhone. Xcode will continue when iPhone is finished."
Step 4 will never finish, only workaround is to turn off Apple Watch completely.
Versions of Hardware & Software:
Mac mini (M1, 2020) @ macOS Monterey V 12.3.1
Xcode @ 13.3.1 (13E500a)
iPhone 13 Pro Max @ iOS 15.4.1
Apple Watch Series 7 (GPS) 41mm @ 8.5.1