      APPLIED RESEARCH ASSOCIATES, INC. AND AFFILIATE,
          PETITIONER v. COMMISSIONER OF INTERNAL
                   REVENUE, RESPONDENT
          Docket No. 21076–11.              Filed October 9, 2014.

         P, an affiliated group consisting of a qualified personal
      service corporation A, the parent corporation, and a corpora-
      tion that is not a qualified personal service corporation, filed
      consolidated Federal income tax returns for 2006 and 2007. P
      reported consolidated taxable income for 2006 and 2007, all of
      which was attributable to A. On the basis that the affiliated
      group, as a single entity, was not a qualified personal service
      corporation, P paid tax on the consolidated taxable income of
      the affiliated group at graduated rates set forth in I.R.C. sec.
      11(b)(1). On the basis that each affiliate’s status as a qualified
      personal service corporation is to be examined separately, R
      determined that the consolidated taxable income of the affili-
      ated group was subject to the I.R.C. sec. 11(b)(2) flat 35% tax
      rate applicable to qualified personal service corporations.
      Held: Graduated rates set forth in I.R.C. sec. 11(b)(1) should
      be used to compute the amount of tax to be imposed on the
      consolidated taxable income of an affiliated group consisting
      of a qualified personal service corporation and an entity that
      is not a qualified personal service corporation where the
      group, as a single entity, is not a personal service corporation.

  Kenneth W. Heathington (an officer), for petitioner.
  Nancy Wentz Hale and Beth A. Nunnink, for respondent.

                                 OPINION

   JACOBS, Judge: The parties submitted this case fully stipu-
lated pursuant to Rule 122. Applied Research Associates, Inc.
(Applied Research), is a corporation organized under the laws
of Tennessee. It provides professional engineering and con-
sulting services and is a qualified personal service corpora-
tion as defined in section 448(d)(2). During the years
310
(310)   APPLIED RESEARCH ASSOCS., INC. v. COMMISSIONER      311


involved (2006 and 2007) Applied Research owned all the
outstanding stock of Oak Crest Land & Cattle Co., Inc. (Oak
Crest), a Texas corporation. During the years involved Oak
Crest owned and operated a 400-acre ranch in Texas which
owned between 200 and 300 head of cattle. Oak Crest is not
a qualified personal service corporation.
   Applied Research and Oak Crest constituted an affiliated
group during the years involved. The affiliated group timely
filed consolidated 2006 and 2007 Federal income tax returns.
Applied Research generated taxable income, whereas Oak
Crest generated a loss, for each of the years involved. The
consolidated return reported taxable income for each of the
years involved.
   The issue for decision concerns the rate(s) of tax (grad-
uated or a flat 35%) to be used to compute the amount of tax
to be imposed by section 11(b) on the consolidated taxable
income of an affiliated group consisting of a qualified per-
sonal service corporation and an entity that is not a qualified
personal service corporation where the group, as a single
entity, is not a qualified personal service corporation. For the
reasons set forth infra, we hold that graduated tax rates
should be used.
   All Rule references are to the Tax Court Rules of Practice
and Procedure, and unless otherwise indicated all section ref-
erences are to the Internal Revenue Code (Code) as in effect
for the years involved. All monetary amounts are rounded to
the nearest dollar. At the time the petition was filed, peti-
tioner’s principal place of business was in Tennessee, and the
parties have stipulated that appeal in this case is to the
Court of Appeals for the Sixth Circuit.

                         Background
  During the years involved Dr. Kenneth Heathington owned
50% of the common stock of Applied Research and his wife,
Dr. Beth Heathington, held the remaining 50%. Dr. Kenneth
Heathington served as president of the corporation, and Dr.
Beth Heathington served as its vice president.
  Dr. Kenneth Heathington is an engineer licensed in Ten-
nessee, Illinois, Indiana, and Mississippi. During the years
involved Dr. Kenneth Heathington provided engineering
services to Applied Research, including lectures and con-
312               143 UNITED STATES TAX COURT REPORTS                    (310)


sulting services; chaired workshops; wrote reports, books and
papers; and provided design work and construction super-
vision for structures that Applied Research owned. He spent
70% to 75% of his working time doing so, billing 1,143.75
hours in 2006 and 1,296.5 hours in 2007. Dr. Beth
Heathington holds a doctorate in education and specializes in
literacy. She has written numerous articles and books in that
field. During the years involved she provided administrative,
financial accounting, and recordkeeping services to Applied
Research, spending 45% to 50% of her working time doing so.
Applied Research paid the Heathingtons, as well as 12
others, nonemployee compensation for their services. 1
   Dr. Kenneth Heathington was president of Oak Crest and
spent between 25% and 30% of his working time farming and
ranching. He vaccinated and branded cattle, purchased and
trained horses, hired and supervised contractors, and pur-
chased equipment for Oak Crest. Dr. Beth Heathington
served as Oak Crest’s vice president and spent 50% to 55%
of her working time on the job at the ranch. Oak Crest paid
nonemployee compensation to four individuals; it paid no
money to either Dr. Heathington.
   Petitioner’s 2006 consolidated Federal income tax return
reported the following: 2
                                                          Consolidated total
      Line item          Applied Research   Oak Crest   reported on Form 1120

Gross receipts              $555,652         $52,030          $607,682
Cost of goods sold              -0-           16,366            16,366
Interest                      12,648           2,972            15,621
Gross rents                    7,200           2,800            10,000
Form 4797 net gain              -0-            2,000             2,000
Other income                    -0-                 3                3
Total income                 575,500          43,439           618,940
Officers’ comp.               50,000            -0-             50,000
Repairs/maintenance           29,156          54,538            83,693
Rents                          1,000           2,796             3,796

  1 The parties stipulated that, when looked at as a separate entity, Ap-

plied Research was a qualified personal service corporation. See infra
p. 316. Although both Doctors Heathington received nonemployee com-
pensation from Applied Research, we assume that as officers who received
remuneration and who provided substantial services to the corporation,
both were employees of Applied Research. See sec. 1.448–1T(e)(5)(ii), Tem-
porary Income Tax Regs., 52 Fed. Reg. 22770 (June 16, 1987); sec.
31.3121(d)–1(b), Employment Tax Regs.
  2 Dollar discrepancies for both the 2006 and 2007 tables result from

rounding of the monetary amounts to the nearest dollar.
(310)     APPLIED RESEARCH ASSOCS., INC. v. COMMISSIONER               313


                                                       Consolidated total
        Line item     Applied Research   Oak Crest   reported on Form 1120

Taxes/licenses             15,830          14,229            30,059
Depreciation                9,824          97,162           106,986
Other deductions          186,304         110,542           296,846
Taxable income            283,387        -235,827            47,560

Petitioner’s 2007 consolidated Federal income tax return
reported the following:
                                                       Consolidated total
        Line item     Applied Research   Oak Crest   reported on Form 1120

Gross receipts           $632,841         $75,918          $708,760
Cost of goods sold           -0-           11,645            11,645
Interest                   13,948           3,084             7,033
Gross rents                 7,200            -0-              7,200
Total income              653,989          67,358           721,347
Officers’ comp.            50,000            -0-             50,000
Repairs/maintenance        43,813          72,935           116,748
Taxes/licenses             12,020          14,229            26,249
Depreciation               78,598          71,377           149,975
Other deductions          204,154          93,442           297,596
Taxable income            265,404        -184,625            80,779

As indicated by the above tables, for each of the years
involved the consolidated taxable income reported on peti-
tioner’s consolidated Federal income tax return was attrib-
utable solely to Applied Research. The affiliated group paid
tax on its consolidated taxable income at graduated rates set
forth in section 11(b)(1).
   On June 9, 2011, respondent issued petitioner a notice of
deficiency with respect to 2006 and 2007. Respondent deter-
mined that the consolidated taxable income reported on both
consolidated returns is subject to the section 11(b)(2) 35%
rate applicable to qualified personal service corporation
income.

                             Discussion
I. Statutory and Regulatory Framework
  For 2006 and 2007 Applied Research and Oak Crest con-
stituted an affiliated group as defined by section 1504(a).
Applied Research was the common parent. See sec. 1504(a).
The affiliated group filed consolidated Federal income tax
returns for both years involved as permitted by section 1501.
  Section 1503(a) provides that in any case in which a
consolidated return is made, the tax shall be determined in
314          143 UNITED STATES TAX COURT REPORTS                       (310)


accordance with the regulations promulgated under section
1502. Section 1502 provides that the Secretary shall pre-
scribe such regulations as he may deem necessary in order
that the tax liability of the affiliated group, and of each of
its members, may be computed, assessed, and collected in
such manner as to clearly reflect its income tax liability and
to prevent avoidance of tax liability. See also Norwest Corp.
& Subs. v. Commissioner, 111 T.C. 105, 153 (1998); Woods
Inv. Co. v. Commissioner, 85 T.C. 274, 277 (1985).
   Section 1.1502–2, Income Tax Regs., provides that the com-
putation of an affiliated group’s tax liability shall be deter-
mined by adding together the following categories of tax:
    (a) The tax imposed by section 11 on the consolidated taxable income
 for such year (see §1.1502–11 for the computation of consolidated taxable
 income);
    (b) The tax imposed by section 541 on the consolidated undistributed
 personal holding company income;
    (c) If paragraph (b) of this section does not apply, the aggregate of the
 taxes imposed by section 541 on the separate undistributed personal
 holding company income of the members of the group which are personal
 holding companies;
    (d) If paragraph (b) of this section does not apply, the tax imposed by
 section 531 on the consolidated accumulated taxable income (see
 §1.1502–43);
    (e) The tax imposed by section 594(a) in lieu of the taxes imposed by
 section 11 or 1201 on the taxable income of a life insurance department
 of the common parent of a group which is a mutual savings bank;
    (f) The tax imposed by section 802(a) on consolidated life insurance
 company taxable income;
    (g) The tax imposed by section 831(a) on the consolidated insurance
 company taxable income of the members which are subject to such tax;
    (h) The tax imposed by section 1201, instead of the taxes computed
 under paragraphs (a) and (g) of this section, computed by reference to
 the net capital gain of the group (see §1.1502–22) (or, for consolidated
 return years to which §1.1502–22 does not apply, computed by reference
 to the excess of the consolidated net long-term capital gain over the
 consolidated net short-term capital loss (see §1.1502–41A for the deter-
 mination of the consolidated net long-term capital gain and the consoli-
 dated net short-term capital loss));
    (i) [Reserved]
    (j) The tax imposed by section 1333 on war loss recoveries; and
 by allowing as a credit against such taxes the investment credit under
 section 38 (see §1.1502–3) and the foreign tax credit under section 33
 (see §1.1502–4). For purposes of this section, the surtax exemption of the
 group for a consolidated return year is $25,000, or if a lesser amount is
 allowed under section 1561, such lesser amount. See §1.1561–2(a)(2). For
(310)   APPLIED RESEARCH ASSOCS., INC. v. COMMISSIONER                     315


  increase in tax due to the application of section 47, see §1.1502–3(f). For
  amount of tax surcharge, see section 51 and §1.1502–7.

   Consolidated taxable income principally represents the
affiliated group’s dealings with the outside world after the
elimination of intercompany profit and loss. See First Nat’l
Bank in Little Rock v. Commissioner, 83 T.C. 202, 209 (1984)
(citing Bittker & Eustice, Federal Income Taxation of Cor-
porations and Shareholders, par. 15.20, at 15–51 (4th ed.
1979)). Section 1.1502–11, Income Tax Regs., provides that
consolidated taxable income is computed by first taking into
account the separate taxable income of each member of the
group. Each member’s separate taxable income is calculated
as if the member were a separate corporation, and then cer-
tain modifications are made for any intercompany trans-
actions and other items. First Nat’l Bank in Little Rock v.
Commissioner, 83 T.C. at 207–208; see sec. 1.1502–12,
Income Tax Regs.
   Once the affiliated group calculates its consolidated taxable
income, section 1.1502–2(a), Income Tax Regs., directs the
affiliated group to apply ‘‘[t]he tax imposed by section 11’’ on
that consolidated taxable income. Section 11(a) imposes a tax
on the taxable income of every corporation. Section 11(b)(1)
provides for graduated rates of tax based on the corporation’s
taxable income. Section 11(b)(2) imposes a flat 35% tax on
the taxable income of a qualified personal service corpora-
tion, as defined in section 448(d)(2). 3
  3 Sec. 448 governs limitations on the use of the cash method of account-

ing. Sec. 448(a) provides that generally (1) C corporations, (2) partnerships
which have a C corporation as a partner, and (3) tax shelters may not com-
pute their taxable income under the cash receipts and disbursements
method of accounting. Pursuant to sec. 448(b)(2), qualified personal service
corporations are excepted from this general rule.
  Sec. 448(d)(2) provides that a corporation is a qualified personal service
corporation if (A) substantially all of its activities involve the performance
of services in the fields of health, law, engineering, architecture, account-
ing, actuarial science, performing arts, or consulting (the function test) and
(B) substantially all of the stock of the corporation, by value, is held di-
rectly, or indirectly through one or more partnerships, S corporations, or
qualified personal service corporations not described in sec. 448(a)(2) or (3),
by (i) employees performing services for the corporation in connection with
the activities involving one of the aforementioned enumerated fields (the
ownership test); (ii) retired employees who had performed such services for
                                                 Continued
316           143 UNITED STATES TAX COURT REPORTS                      (310)


   Although for purposes of the imposition of tax, section 11
makes a distinction for entities that are qualified personal
service corporations and those that are not, section 1.1502–
2(a), Income Tax Regs., does not make such a distinction.
Section 1.1502–2, Income Tax Regs., first addressed computa-
tion of tax liability in 1966 in T.D. 6894, 1966–2 C.B. 362,
366. At that time, section 11(b) provided that all corporations
were subject to graduated tax rates. 4 In 1987 the Revenue
Act of 1987 (RA 1987), Pub. L. No. 100–203, sec. 10224(a),
101 Stat. at 1330–412, amended section 11(b) to prevent
qualified personal service corporations from reaping the
benefits of graduated corporate tax rates. However, section
1.1502–2(a), Income Tax Regs., was not updated to reflect the
1987 amendment to section 11(b). Thus, section 1.1502–2(a),
Income Tax Regs., for the years involved, retained the rule
that consolidated taxable income is a singular item and does
not provide different tax rates for qualified personal service
corporations.
II. Contentions of the Parties
   The parties have stipulated that Applied Research, if
considered by itself, was a qualified personal service corpora-
tion for both years involved. Further, the parties agree that
if examined as a separate entity, Oak Crest was not a quali-
fied personal service corporation for the years involved.
the corporation; (iii) the estate of any individual described in the two pre-
vious clauses; or (iv) any other person who acquired the stock by reason
of the death of any of the aforementioned individuals, but only for the two-
year period beginning on the date of the death of that individual.
  4 Before the enactment of the Revenue Act of 1987, Pub. L. No. 100–203,

sec. 10224(a), 101 Stat. at 1330–412, sec. 11(b) provided:
  SEC. 11. TAX IMPOSED.
    (b) AMOUNT OF THE TAX.—The amount of tax imposed by subsection
  (a) shall be the sum of—
       (1) 15 percent of so much of the taxable income as does not exceed
    $50,000;
       (2) 25 percent of so much of the taxable income as exceeds $50,000
    but does not exceed $75,000;
       (3) 34 percent of so much of the taxable income as exceeds $75,000.
  In the case of a corporation with taxable income in excess of $100,000
  for any taxable year, the amount of tax determined under the preceding
  sentence for such taxable year shall be increased by the lesser of (A) 5
  percent of such excess, or (B) $11,750.
(310)   APPLIED RESEARCH ASSOCS., INC. v. COMMISSIONER                317


   The parties disagree as to the tax rate to be imposed on
the consolidated taxable income of an affiliated group when
a qualified personal service corporation and another type of
corporation combine to form the affiliated group and file a
consolidated income tax return. Respondent asserts that in
that situation each member corporation is to be examined
separately to determine whether it is a qualified personal
service corporation. Respondent further asserts that if at
least one member of the affiliated group is determined to be
a qualified personal service corporation, the consolidated tax-
able income of the group is to be split or broken up into sepa-
rate baskets, one for the income of the qualified personal
service corporation and another for the income of the other
type of corporation. And, respondent maintains, after doing
so, a flat 35% rate is to be applied to the qualified personal
service corporation’s income and graduated rates are to be
applied to the income of the corporation that is not a quali-
fied personal service corporation.
   In contrast, petitioner asserts, in essence, that because the
consolidated return regulations do not provide for the split-
ting of an affiliated group’s consolidated taxable income after
the affiliated group’s consolidated taxable income has been
calculated, the entire amount of consolidated taxable income
of the affiliated group is taxed at graduated rates.
   The parties agree that if the affiliated group’s consolidated
taxable income may not be split into two separate baskets,
the entire amount of the consolidated taxable income of the
affiliated group is taxed at graduated rates. On the other
hand, the parties agree that if the affiliated group’s consoli-
dated taxable income can be split into separate baskets, then
inasmuch as all of the consolidated taxable income of the
affiliated group is attributable to the operations of Applied
Research, a qualified personal service corporation, all of peti-
tioner’s taxable income is subject to the flat 35% rate. 5
  5 In his brief respondent notes that sec. 1.1502–2(e), Income Tax Regs.,

imposes a tax on a life insurance department’s income without netting it
against any losses of the consolidated group. Respondent asserts that this
section grants him authority to impose the qualified personal service cor-
poration’s tax rate on the entire amount of income attributable to the
qualified personal service corporation member without taking into consid-
eration losses suffered by other members of the affiliated group. However,
                                              Continued
318           143 UNITED STATES TAX COURT REPORTS                     (310)


III. Analysis
   The consolidated return regulations are intended to bal-
ance what this Court described in Norwest Corp. & Subs. v.
Commissioner, 111 T.C. at 152, as ‘‘two countervailing prin-
ciples of the law relating to consolidated returns’’. The first
of these principles is that ‘‘the purpose of the consolidated
return provisions * * * is ‘to require taxes to be levied
according to the true net income and invested capital
resulting from and employed in a single business enterprise,
even though it was conducted by means of more than one
corporation.’ ’’ First Nat’l Bank in Little Rock v. Commis-
sioner, 83 T.C. at 209 (quoting Handy & Hartman v. Burnet,
284 U.S. 136, 140 (1931)). The contrasting second principle
is that ‘‘ ‘[e]ach corporation is a separate taxpayer whether it
stands alone or is in an affiliated group and files a consoli-
dated return.’ ’’ Wegman’s Props., Inc. v. Commissioner, 78
T.C. 786, 789 (1982) (quoting Elec. Sensing Prods., Inc. v.
Commissioner, 69 T.C. 276, 281 (1977)); see also secs. 1.1502–
21A(f), 1.1502–12, Income Tax Regs.
   Calculating consolidated taxable income requires an affili-
ated group to combine its members’ separate taxable
incomes, as defined in section 1.1502–12, Income Tax Regs.,
into one unitary amount. See sec. 1.1502–11, Income Tax
Regs. Section 11, on the other hand, provides different taxing
regimes, one for qualified personal service corporations and
another for corporations that are not qualified personal
service corporations. Thus, the resolution of the issue in this
case requires us to decide whether we should (1) treat each
member of the affiliated group separately and break the
affiliated group’s consolidated taxable income into separate
baskets: one for the income of the qualified personal service
corporation and another for the other corporation or (2) treat
the affiliated group as a single entity and not break up the
affiliated group’s consolidated taxable income into separate
baskets.

respondent states he took a ‘‘more conservative approach in this case to
allow the members to net their income before applying the qualified per-
sonal service corporation tax rate’’. Because of respondent’s concession, we
need not and do not consider netting losses against qualified personal serv-
ice corporation income.
(310)   APPLIED RESEARCH ASSOCS., INC. v. COMMISSIONER       319


   Respondent asserts that where one member of an affiliated
group is a qualified personal service corporation and another
is not, the consolidated taxable income of the affiliated group
must be broken up into two separate baskets. Respondent
argues that section 448 requires that the determination as to
whether a corporation is a qualified personal service corpora-
tion is to be made at the entity level, not at the level of the
affiliated group. Further, respondent posits that the Code
provides for treating qualified personal service corporate
members of an affiliated group differently from other mem-
bers. We disagree.
   Although section 448(d)(4) provides special rules by which
members of an affiliated group may determine their status as
a qualified personal service corporation in electing whether
to use the cash method of accounting, it provides no illumina-
tion as to the rate of tax to be applied to the consolidated
taxable income of the entire group. Nor does section 448(d)(4)
provide support for the proposition that the consolidated tax-
able income of an affiliated group is to be broken up into
separate baskets.
   Respondent maintains that because Applied Research is a
qualified personal service corporation, when considered
alone, it holds a ‘‘special status’’. Respondent asserts that
when a member of an affiliated group has a ‘‘special status’’,
the tax applicable to that member is calculated and added to
the non-special-status members’ tax under section 11. This,
respondent claims, is the regime provided by paragraphs (b)
through (j) of section 1.1502–2, Income Tax Regs. To support
this assertion, respondent cites section 1.1502–2(g), Income
Tax Regs., which adds the tax imposed by section 831(a) on
consolidated insurance company taxable income to the tax
liability of the affiliated group. Respondent posits that just as
insurance company income is taxed separately from the affili-
ated group’s consolidated taxable income, qualified personal
service corporation income is to be taxed separately from the
affiliated group’s consolidated taxable income. We disagree.
   Paragraphs (b) through (j) of section 1.1502–2, Income Tax
Regs., enumerate taxes to be added to an affiliated group’s
tax liability. Qualified personal service corporate income is
not one of the enumerated special types of income. Indeed,
far from providing qualified personal service corporations
with special status, section 1.1502–2(a), Income Tax Regs.,
320        143 UNITED STATES TAX COURT REPORTS             (310)


includes the income of qualified personal service corporations
in the affiliated group’s consolidated taxable income.
   Respondent next argues that Applied Research and Oak
Crest are, in reality, two separate corporations that have
been permitted to file a consolidated return. Respondent
analogizes the facts in this case to the facts in Specialty
Rests. Corp. v. Commissioner, T.C. Memo. 1992–221. In Spe-
cialty Rests. Corp., the taxpayer (a parent corporation)
incurred startup costs for its subsidiary restaurants. On its
tax return, the taxpayer deducted these preopening costs
under section 162. We rejected the taxpayer’s position,
finding that the subsidiaries were separate legal entities. We
thus held that the expenses were preopening expenses of the
subsidiaries and represented capital contributions by a
parent corporation to its subsidiaries.
   The facts of Specialty Rests. Corp. are distinguishable from
those in the instant matter. In rejecting the taxpayer’s posi-
tion, we emphasized that the subsidiaries had not begun
operations at the time the expenses were incurred and thus
the subsidiaries’ expenses were not properly deductible under
section 162. In this case, Applied Research and Oak Crest,
as members of an affiliated group filing a consolidated
return, were operating companies, and respondent has con-
ceded that Applied Research and Oak Crest are permitted to
net their incomes and expenses.
   Petitioner argues that the affiliated group must be exam-
ined as a single, unitary entity for purposes of determining
the proper tax rate to be applied to the affiliated group’s
consolidated taxable income. Petitioner’s primary argument
is that there is no guidance in the Code, the regulations, or
other authority regarding the method of establishing the
proper rate or rates of tax on consolidated taxable income
where one member, but not all members, of the affiliated
group is a qualified personal service corporation. While peti-
tioner is correct that there is no guidance with respect to
such a situation, acceptance of petitioner’s position is fraught
with danger. Section 11(b) was intended to deny the benefits
of graduated corporate income tax rates to qualified personal
service corporations. See RA 1987 sec. 10224(a); H.R. Rept.
No. 100–391 (Part 2), at 1097 (1987). Although we can envi-
sion circumstances where this intent could be circumvented
(310)   APPLIED RESEARCH ASSOCS., INC. v. COMMISSIONER                  321


by petitioner’s position, we are nevertheless compelled to find
in favor of petitioner.
  Our conclusion is bolstered by our holding in Woods Inv.
Co. v. Commissioner, 85 T.C. 274 (1985). In that matter, the
taxpayer filed a consolidated return for itself and its four
wholly owned subsidiaries. The subsidiaries used accelerated
depreciation as provided by section 1.1502–32, Income Tax
Regs. However, when the taxpayer parent sold the subsidi-
aries, it determined its basis in the subsidiaries’ stock using
straight-line depreciation as provided by section 312(k). The
Commissioner determined that the taxpayer’s straight-line
depreciation gave it a ‘‘double deduction’’ and reduced the
taxpayer’s basis in the subsidiaries’ stock.
  We rejected the Commissioner’s position and sustained the
taxpayer’s basis adjustments. We noted that section 312(k)
was enacted after section 1.1502–32, Income Tax Regs., was
promulgated; that the Commissioner was aware of the inter-
play between section 312(k) of the Code and section 1.1502–
32, Income Tax Regs.; and that the Commissioner had failed
to amend his regulations to reflect his litigating position.
Woods Inv. Co. v. Commissioner, 85 T.C. at 281. We stated:
     If respondent believes that his regulations and section 312(k) together
  cause petitioner to receive a ‘‘double deduction,’’ then respondent should
  use his broad power to amend his regulations. See Henry C. Beck
  Builders, Inc. v. Commissioner, 41 T.C. 616, 628 (1964). Since
  respondent has not taken steps to amend his regulations, we believe his
  apparent reluctance to use his broad power in this area does not justify
  judicial interference in what it essentially a legislative and administra-
  tive matter. Henry C. Beck Builders, Inc. v. Commissioner, supra
  (Drennen, J., concurring at page 633). [Id. at 282.]

See also Gottesman & Co. v. Commissioner, 77 T.C. 1149,
1158 (1981) (refusing to ‘‘fill in the gaps’’ in the regulations
with respect to the imposition of accumulated earnings tax
on corporations filing consolidated returns).
  In computing the proper tax liability of an affiliated group,
we begin with section 1.1502–2, Income Tax Regs. Section
1.1502–2(a), Income Tax Regs., does not distinguish between
taxable income under section 11(b)(1) and (2), and we find no
authority to permit the breakup of an affiliated group’s
consolidated taxable income into separate baskets. We look to
the affiliated group as a whole, i.e., the entity which gen-
erated the consolidated taxable income, to determine the
322        143 UNITED STATES TAX COURT REPORTS             (310)


characterization of the consolidated taxable income. And in
this regard, the parties agree that, when viewed as a whole,
Applied Research’s affiliated group is not a qualified personal
service corporation.
   To conclude, we hold that in the situation involved herein,
graduated rates set forth in section 11(b)(1) should be
applied to the affiliated group’s consolidated taxable income.
In reaching our holding, we have considered all of the
contentions and arguments of the parties that are not dis-
cussed herein, and we find them to be either without merit,
irrelevant, or moot.
   To reflect the foregoing,
                        Decision will be entered for petitioner.

                        f
