1. An IRS agent has just begun examining the last three years of tax returns filed by Evan and Magic. He has questioned whether the $50,000 withdrawals should be characterized as salary payments to Evan instead of shareholder distributions. What are the income tax consequences to Evan and Magic if these distributions are characterized as salary payments? If the payment is re-categorized as salary, the S corporation is allowed a deduction, reducing its taxable income. Therefore, Evan must report the payment as salary income. An S corporation can make various payments to its shareholders, such as salaries, dividends, reimbursement of expenses, loan repayments, and profit distribution. Wages and salaries paid to S corporation shareholders should be reported on Form W-2. Evan's taxable income and tax liability are zero since he is the sole shareholder