1. Double taxation is avoided
Double taxation occurs when a corporation pays income tax on corporate net income, and then the shareholders pay tax on any dividend income they receive from the corporation (This often occurs with C corporations). Double taxation hits particularly hard when a company is sold.

By becoming an S corporation, profits and losses flow directly through to the owners in proportion to their ownership percentages. For example, a 10% owner would receive 10% of the profits or losses.

Since profits and losses flow through and are taxed on the individual, there is no federal tax on the corporation itself. California does tax S corporations on the corporate level, but at much lower rates than C corporations. The remaining income flows through to the shareholders for a second layer of California taxation.

2. Avoidance of self-employment tax by the shareholder of the corporation
Sole proprietors and independent contractors are subject to self-employment tax at a rate of over 15%. A self-employed person who forms an S corporation and becomes an employee of that corporation is no longer subject to self-employment tax because that person will no longer be self-employed. This applies even if that person is the corporation's sole shareholder and employee.

However, reasonable wages are required to be paid to the shareholder/employee and payroll taxes must be paid on this amount.