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Many tax and legal experts recommend S Corporation status for smaller entities and start-ups. It can provide you with corporate liability protection, and potentially reduces your tax burden (since corporate income is taxed at one level instead of two). In addition, if your business experiences a loss in its first year, you can generally pass that loss through to your personal income tax return. There are other potential tax advantages as well, including the ability to deduct (as an investment interest expense) interest you incur to buy S Corporation stock.
The disadvantage of an S Corporation is that they are limited in terms of the amount of deductions for fringe benefits such as heath insurance, group term life insurance, deferred compensation plans, etc. While a C Corporation can deduct these benefits for all owner-employees, an S Corporation cannot deduct them for an owner-employee who owns 2% or more of the corporate stock.
To become an S Corporation, all shareholders must file and sign IRS Form 2553. Shareholders pay income tax on their share of the corporation's income, regardless of whether they actually received the money or not. If the corporation suffered a loss, shareholders can claim their share of that loss.
