A taxpayer operates an illegal drug trafficking business. Which of the following expenses are deductible for tax purposes?

Answer options:

Cost of Goods Sold (COGS) only.

All ordinary and necessary business expenses.

No expenses are deductible.

Rent and wages, but not bribes.

How to approach this question

Recall IRC §280E. Illegal drug businesses can ONLY deduct COGS. Nothing else.

Full Answer

A.Cost of Goods Sold (COGS) only.✓ Correct

Under IRC §280E, no deduction or credit is allowed for any amount paid or incurred in carrying on a trade or business that consists of trafficking in controlled substances. However, Cost of Goods Sold (COGS) is a reduction of gross receipts (return of capital), not a 'deduction', and is constitutionally required to be allowed to determine gross income.

Common mistakes

Thinking illegal businesses can deduct rent/wages (true for illegal gambling, but NOT for drugs).

Question 71 All questions

Practice the full CPA REG Practice Exam 2

72 questions · hints · full answers · grading

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