The election to be taxed as an “S” corporation is made by filing IRS form 2553 with the IRS. Once that is properly completed, the corporation is taxed as a "pass through" entity.
That means the “S” corporation almost never pays taxes itself. Instead, it files form 1120S with the IRS and issues the shareholders K-1 forms. The K-1 forms show the shareholders portion of the net income of the corporation. So, if the shareholder owns a 25% interest in the corporation and the corporation’s net income is $200,000, the K-1 for that shareholder will show $50,000 of income. The corporation's income thus passes through to the shareholders.
The big drawback is that the shareholder has to include the K-1 income on his tax return even if he received no money from the corporation. This could mean the shareholder has to pay taxes on income he hasn’t actually received.
But, since only the shareholder will pay taxes on the income, the maximum tax rate is approximately 35%. This saves about 10% of the net income from taxes!