There are many factors to take into account when choosing the most favorable business entity for your start-up, such as management style, the source of your financing, what kind of products or services you offer, liability risk, and tax considerations.
For many small companies, setting up an S corporation can be an effective way to avoid the self-employment tax and double taxation on corporate income. The idea, according to the IRS, is that income, losses, tax deductions and credits pass through to the shareholders, who then pay any federal taxes due when they file their individual tax returns.
In a recent, widely-reported case, one S corp’s 2006 tax return was audited, and IRS decided it had underpaid its employment taxes by reporting the president’s salary. Although there was apparently an agreement in place that his annual salary would be $24,000, Forbes reports that the his salary was reported as zero on that tax form.