An S corporation is merely a C corporation that has filed an election with the IRS to be taxed as a pass-through entity like a partnership. In other words, the S corporation is not a separate taxable entity, but is otherwise a C corporation in all respects. S corporations are formed under state law in the same manner as C corporations. In fact, from the perspective of state corporation law, these are the same entities. The designations “C” and “S” refer to the subchapters of the Internal Revenue Code under which a corporation is taxed.

The S corporation’s stockholders are taxed on all income or recognize all losses produced by the corporation. For many early stage companies that are bootstrapping with funding from founders and their friends and family, filing an S election may make sense because the initial funders may be able to utilize the tax losses of the entity. The S corporation election does not need to be permanent. For example, if an S corporation is ready to raise venture capital funding, its board can revoke the “S” elections and revert to “C” corporation status.

Similar to a limited partnership and a limited liability company, an “S” corporation’s income is taxed to its stockholders regardless of whether the corporation distributes any income to its stockholders. This means that stockholder may be taxed on income that they do not actually receive. The state of California taxes the income of a Chapter S corporation to the extent of 1.5% of income, but not less than $800 per year.

It is not always easy to qualify as an S corporation. An S corporation cannot have more than 100 stockholders, and none of the stockholders can be entities or non-residents of the United States. In effect, this means that an S corporation cannot take institutional investment because institutional investors are always entities.

S corporations are not the norm for Silicon Valley technology companies.