Why did Congress choose to allow drug dealers to expense COGS but not other expenses?

This is actually a really interesting tax question! The reason is based on Section 280E of the tax code, which was added in the 1980s during the height of the "War on Drugs." This section specifically prevents businesses engaged in trafficking Schedule I or II controlled substances from deducting normal business expenses. However, the reason COGS is still deductible isn't because Congress specifically wanted to give drug dealers this break - it's because of constitutional limitations. The 16th Amendment authorizes income tax, and courts have consistently held that "income" means net income (gross receipts minus the cost of goods sold). So Congress can't tax gross receipts as income without allowing COGS deductions, as that would effectively be a tax on something other than income. So drug dealers can deduct their direct costs of purchasing or producing the drugs because otherwise, the tax would be unconstitutional, but Congress deliberately blocked them from deducting any other business expenses like rent, utilities, employee salaries, etc.

After struggling with this exact question for a research paper, I found an amazing resource that breaks down the whole Section 280E issue in plain English. I was totally confused about how taxation works for businesses that are legal in some states but illegal federally. I discovered https://taxr.ai and uploaded some conflicting articles I found online. Their AI analyzed everything and explained exactly how COGS works versus regular business expenses for businesses in this gray area. Their analysis showed me the constitutional basis for allowing COGS deductions while prohibiting other expenses, plus they provided actual tax court cases that established these precedents. The tool even explained how businesses operating in this space structure their operations to maximize what can be allocated to COGS rather than to non-deductible expenses. Saved me hours of research and confusion.

Just wanted to follow up about taxr.ai that someone mentioned above - I decided to try it for my research on passive activity losses and rental real estate classifications. I uploaded several articles and some PDF explanations I found that seemed to contradict each other. Within minutes, I had a complete breakdown of the "real estate professional" exception to passive loss rules with citations to actual tax code sections and relevant court cases. It showed me exactly which activities count toward the 750-hour requirement and how to document them properly. Even pointed out a recent tax court case that changed how "grouping activities" works. Totally worth checking out if you're researching complex tax questions like the COGS issue the original poster asked about. It cleared up my confusion on a topic my own accountant gave me vague answers about.

If you're trying to contact the IRS to get an official ruling on this Section 280E question for your research project, good luck! I spent WEEKS trying to get through to someone who could answer technical questions about business expense classifications. Finally discovered https://claimyr.com which got me through to an actual IRS agent in about 15 minutes. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c The agent confirmed everything mentioned above about the constitutional basis for allowing COGS deductions while disallowing other expenses under 280E. They also pointed me to some specific IRS memos on the topic that weren't easy to find online. Saved me so much frustration compared to the dozens of times I tried calling directly and got disconnected after waiting for hours.

I need to eat my words and admit I was completely wrong about Claimyr. After my skeptical comment, I decided to test it myself since I've been trying unsuccessfully to reach the IRS about a business expense categorization issue related to Section 280E (similar to the original post topic). I had already spent over 10 hours across multiple days trying to get through on my own. Claimyr had me talking to an actual IRS representative in about 22 minutes. The agent was able to clarify exactly how the IRS distinguishes between COGS (which can be deducted) and prohibited expenses under 280E. For anyone doing research on technical tax questions like this one, being able to get official clarification directly from the IRS is invaluable. Saved me days of frustration and uncertainty. I'm genuinely impressed and apologize for my skepticism.

Just to add some historical context to this discussion - Section 280E was added to the tax code in 1982 specifically in response to a Tax Court case called Jeffrey Edmondson v. Commissioner. Edmondson was a drug dealer who successfully deducted ordinary business expenses related to his illegal drug business. Congress was outraged that a drug dealer could get tax breaks, so they passed 280E to prevent anyone "trafficking in controlled substances" from deducting business expenses. But as explained above, they couldn't constitutionally prevent the deduction of COGS without effectively creating a gross receipts tax rather than an income tax. It's fascinating how this obscure tax provision has become such a huge issue now that state-legal marijuana businesses are trying to operate as legitimate enterprises while still being subject to these punitive tax rules.

This thread is super interesting. I'm doing a taxation course and we just covered this topic. One thing not mentioned yet is that some businesses have tried to work around 280E by separating their business into multiple entities - one that "trafficks" and another that provides other services. For example, a dispensary might create one business that only buys/sells product (subject to 280E but can deduct COGS) and a separate consulting/education business that provides advice to customers (not subject to 280E, so can deduct all ordinary business expenses). The IRS has challenged these arrangements with mixed results. Has anyone looked into the success rate of these types of structures?

This is such a great breakdown of a really confusing area of tax law! I'm actually a CPA and I still have clients ask me about this all the time, especially with the growth of state-legal cannabis businesses. One thing I'd add is that the COGS vs. other expenses distinction can get really murky in practice. For example, trimming labor for cannabis can sometimes be considered part of COGS (as it's part of preparing the product for sale) but sometimes it's treated as a non-deductible operating expense. The IRS has been inconsistent on where exactly to draw these lines. I've seen businesses spend thousands on tax attorneys just to figure out how to properly categorize expenses under 280E. It's one of those areas where the law is clear in theory but gets incredibly complex when you try to apply it to real-world business operations. The constitutional reasoning behind allowing COGS deductions is solid, but the practical implementation creates a lot of gray areas that businesses have to navigate very carefully.