(a) The requirement is to determine whether the cost of
merchandise, and business expenses other than the cost of merchandise,
can be deducted in calculating Mock’s business income
from a retail business selling illegal narcotic substances. Generally,
business expenses that are incurred in an illegal activity are
deductible if they are ordinary and necessary, and reasonable in
amount. Under a special exception, no deduction or credit is
allowed for any amount that is paid or incurred in carrying on a
trade or business which consists of trafficking in controlled substances.
However, this limitation that applies to expenditures in
connection with the illegal sale of drugs does not alter the normal
definition of gross income (i.e., sales minus cost of goods sold).
As a result, in arriving at gross income from the business, Mock
may reduce total sales by the cost of goods sold, and thus is allowed
to deduct the cost of merchandise in calculating business