You have to apply for S-corp status on form 2553. The IRS will eventually acknowledge your election by letter or reject it. Don't hold your breath waiting for a reply, however.
What that sentence means is that for an s-corp, the owners have to pay themselves a "reasonable" salary with all of the formalities of filing 941s, issuing a W-2 and filing a W-3 etc. Any income left over goes to the owner(s) via a K-1. This income would not be subject to payroll taxes (social security and Medicare). That's the whole idea behind the reasonable compensation issue- the avoidance of social security and Medicare taxes.
