S corporations combine the most beneficial aspects of partnerships and corporations. Like standard C corporations, a properly formed, properly capitalized and properly maintained S Corporation should protect the owners from liability other than their capital contribution. S corporations, however, avoid the double-taxation problems of C corporations.

In making an “S” election with the IRS, the corporation elects to pass corporate income, losses, deductions and credits through to the shareholders (in proportion to their percentage of ownership) for federal tax purposes. Each shareholder must then report the flow-through of income and losses his or her personal tax return and pay taxes at his or her standard income tax rate.

S corporations are often a good choice for start-ups because of the limited liability, flow-through tax treatment, and possible payroll tax advantages they offer. Not everyone, however, can be the owner of an S-corp. There be no more than 75 shareholders, other corporations cannot serve as shareholders, foreign citizens cannot be shareholders, and only one class of stock may be issued.

For taxation purposes, S corporations must file IRS Form 1120S U.S. Income Tax Return for an S Corporation to report all income, gains, losses and deductions for the company. The company may also need to make estimated payments for (a) the tax on built-in gains, (b) the excess net passive income tax and (c) the investment credit recapture tax. Additionally, like all businesses, the S corporation must pay employment taxes, including Social Security, Medicare and unemployment.

Corporations, whether C corporations or S corporations, are formed by filing articles of incorporation with the Secretary of State. So long as they are properly formed, properly capitalized and properly maintained, they should shield the owners from personal liability for the debts and obligations of the company, except for the amount of their capital contribution.

The owners are called shareholders, and are issued shares of stock. The shareholders elect a board of directors, who then elect officers to carry out the day to day business of the corporation. Often times in small corporations, the same individual or individuals can serve as shareholders, directors, and officers.

To be properly formed, a corporation must have an organizational meeting and issue shares. It is not enough to merely file articles of incorporation with the secretary of state. Each year it must hold annual meetings of shareholders and directors and file an annual report with the secretary of state.

When it comes to taxes, a corporation has its own tax identification number and pays taxes just like an individual. IT must file an annual form 1120 U.S. Corporation Income Tax Return as well as quarterly estimated taxes. A corporation generally is entitled to the same deductions as a sole proprietor and can take additional special deductions only available to corporations.

C corporations may offer several tax advantages, however, with respect to deductibility of retirement contributions, group insurance premiums, and other benefits. The main downside to forming a C-corporation is double-taxation: the corporation itself pays taxes on profits when the income is earned and the shareholder also pays tax on dividends. For this reason, few small businesses are C-corporations.