An S Corporation gets its name from the subchapter of the Internal Revenue Code that determines it is not a taxpaying entity, but is a conduit that passes gains and losses on to its shareholders. It is a separate legal entity in terms of providing liability protection to its owners from business creditors. This best-of-both-worlds aspect is why an S corporation is chosen for some businesses instead of the other corporate forms.

A corporation is a legal entity, separate from its owners or shareholders. A corporation can own property, enter into contracts and pursue business activities. The separation of a corporation from its owners has implications for the life span and liability of a corporation.

State laws specify formalities in order to form a corporation. At minimum, articles of incorporation must be filed with the secretary of state. In some states, the articles must also be recorded with the register of deeds in the county in which the corporation is located. An S corporation must also file a special S election with the federal tax authorities.

Because a corporation is a separate legal entity, it has a "perpetual life"—that is, there is no specific time limit on how long the corporation can exist. Also, there is no relationship between the life of a corporation and the lives of its owners. For example, the death of the sole owner of a corporation does not result in its dissolution.

Shares of stock can easily be transferred in an S corporation during the lifetime of an owner or at the owner's death. However, there are restrictions that limit the transferability of stock. An S corporation can have no more than 75 shareholders. Also, shareholders can only be individuals, estates, certain tax-exempt organizations and certain trusts.

A corporation consists of shareholders and a board of directors. The directors usually employ officers and other employees to oversee the day-to-day operation of the business. In a small business, there is often little distinction between the shareholders, the board and the officers. Frequently, these roles and responsibilities are carried out by the same people.

Because a corporation is a separate legal entity, the corporation is liable for its own debts and other business liabilities. Liability is limited to the assets of the corporation—in other words, the owners of a corporation do not expose their personal assets to corporate liability.

An S corporation is generally not a separate taxable entity. As a result, the corporation does not pay taxes on its net income. The net profits or losses of the corporation pass through to the owners.

An S corporation can deduct the cost of employee benefits as a business expense. However, more than 2% shareholders are generally not considered employees for income tax purposes.

Finally, income can be shifted to other family members by making them employees and/or shareholders of the corporation. Appreciation can also be shifted to other family members as a way to minimize death taxes when an owner dies.

Conceptually simple method of taxation (although strict IRS rules must be adhered to); income and losses pass through to owners; limited liability of shareholders; perpetual life; ability to shift income and appreciation to others.

Income and losses pass through to owners; S corporation restrictions limit the number (75) and types (individuals, estates and certain trusts) of shareholders; lack of ability to use tax advantages of certain benefits.

C Corporation, closely held corporation, professional corporation.