When deciding whether to elect to treat your corporation as an S Corporation, you should know the main difference between S and C is the corporation’s tax structure.

Once you incorporate your business, you will generally have to decide within about two and a half months whether you want to remain a C Corporation or file a form 2553 with the IRS to become an S Corporation.

In an S Corporation, the shareholders are taxed similarly to the stakeholders in a partnership or sole proprietorship. Income from the business flows through to the shareholders, who are taxed on that income.  The S Corporation still must file a federal tax return, but the corporation itself does not pay taxes.  In other words, an S Corporation avoids the “double taxation” of C Corporations in which taxes are paid by shareholders and the corporation itself. In a C Corporation, shareholders report income from the corporation on their 1040 form.

S Corporations have a number of restrictions that C Corporations do not. For example, the company must be incorporated in the United States, it cannot have foreign shareholders, it cannot have more than 100 shareholders, and all shareholders must be individuals.

The S Corporation has some clear tax advantages in addition to avoiding, in most cases, double taxation. One of those advantages is that losses the corporation incurs may be taken against income on personal tax returns by the corporation’s shareholders.

The S Corporation was designed for small businesses that require more structure than afforded by partnerships or even LLCs. To determine whether an S Corporation structure is the best fit for your company, carefully examine the benefits and disadvantages of such a structure before making this important decision.