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But all along, these entities were really just small corporations that used a set of tax accounting rules found in a subchapter of tax law. When state legislatures started allowing people to form new-and-improved business entities like limited liability companies, the IRS decided to allow these entities to also use the same "Subchapter S" accounting rules if they wanted.
Note: The Wyoming legislature was the first to create the laws that allowed for a limited liability company, and did so in 1977.
Self-employment taxes (as well as the equivalent Social Security and Medicare taxes), run about 13% (after making some adjustments you don't need to worry about right now).
But you see where the savings come: If a business owner avoids that 13%-ish employment tax on ,000 of profits, the savings roughly equal ,000 to ,000 a year.
The primary difference between C corporations and S corporations is that C corporations are taxed twice on earned income: : once at the corporate level when the income is earned, and again at the shareholder level when the income is distributed.
But that wasn't a problem when, for all practical purposes, only sole proprietorships, partnerships and corporations even existed for business tax law purposes.
Predictably, people started calling these corporations which made the election to use the rules "Subchapter S corporations" and then, later, "S corporations" or "S corps".
This subchapter, which was based on a proposal from President Eisenhower, gave corporations with just a handful of individual shareholders the option to be taxed like partnerships.
This meant among other things that the corporation wasn't taxed on its profits.