The IRC is influenced by social considerations regarding activities that are considered contrary to the public's well-being. For example, the all-inclusive approach for gross income includes income and gains from illegal and criminal activities (eg, sale of illegal drugs).

In general, all ordinary and necessary expenses incurred in operating a business are deductible. However, the IRC specifically disallows deductions for the trade or business expenses associated with illegal drug activity (Choices A and C). Because the cost of inventory (ie, cost of goods sold) is a fundamental part of calculating the gross profit on the sale of goods, it is the only expense allowed for illegal drug activities in determining net taxable income (Choice D).

Although Mock must report all of the income from the sale of illegal substances, he may deduct only the cost of the merchandise in arriving at net taxable business income.

Things to remember:
The all-inclusive approach for gross income includes income and gains from illegal and criminal activities (eg, sale of illegal drugs). Although all ordinary and necessary expenses incurred in operating a business are generally deductible, only the cost of goods sold is deductible for illegal drug activities.