Final answer:
Special allocations in partnerships are allowed and common practice, provided they meet the substantial economic effect test, reflecting the true economic agreement between partners. Option d is the correct answer.
Step-by-step explanation:
Special allocations by partnerships refer to the specific way that a partnership divides its tax items amongst its partners. Unlike salary allocations in a corporation where each employee has a set wage, partnerships have the flexibility to distribute income, loss, deductions, and credits among the partners in a way that does not necessarily reflect their ownership percentages.
Answering the question, special allocations by partnerships are permitted, as long as these allocations meet the substantial economic effect test. This doctrine is anchored in the United States Internal Revenue Code and Treasury Regulations, which provide that allocations must be consistent with the underlying economic arrangement of the partners. In essence, the allocations should reflect the economic reality of the partners' agreement. Should the allocations not meet the substantial economic effect, they could be reclassified by the Internal Revenue Service (IRS).
It is not required that special allocations must be offset by later special allocations, although subsequent allocations may impact whether earlier allocations are deemed to have substantial economic effect. Ultimately, the allocations must conform to the partnership agreement and the respective contributions and distributions of the partnership's income or loss among its partners.