What type of allocation must be used for flow-through S corporation items?

The correct answer is that a per-day, per-share allocation must be used for flow-through S corporation items. This method ensures that income, deductions, and other tax attributes are allocated to shareholders based on their ownership interest in the S corporation on a daily basis throughout the tax year.

This approach takes into account that shareholders may acquire or dispose of their shares during the year, meaning the allocation of income or loss they receive should reflect the number of days they held those shares. Therefore, if a shareholder holds shares for part of the year but not the entire year, they will only report their share of the corporation's income or losses relative to the time they were an owner, providing a fair reflection of their investment in the S corporation.

This precision is particularly important in maintaining compliance with tax regulations and ensuring that shareholders accurately report their income. It also facilitates clear documentation for the Internal Revenue Service, as allocations must be transparent and easily verifiable based on ownership periods.

In summary, a per-day, per-share allocation method results in a fair distribution of items to shareholders, in line with the flow-through nature of S corporations, where income is reported directly on the shareholders' tax returns.