310

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 corporation 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 affiliated 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 stipulated pursuant to Rule 122. Applied Research Associates, Inc. 

(Applied Research), is a corporation organized under the laws 

of Tennessee. It provides professional engineering and consulting services and is a qualified personal service corporation as defined in section 448(d)(2). During the years 
(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 (graduated 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 personal 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 references 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, petitioner’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 Tennessee, 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) 

1The parties stipulated that, when looked at as a separate entity, Applied Research was a qualified personal service corporation. See infra 

p. 316. Although both Doctors Heathington received nonemployee compensation 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), Temporary Income Tax Regs., 52 Fed. Reg. 22770 (June 16, 1987); sec. 

31.3121(d)–1(b), Employment Tax Regs. 2Dollar discrepancies for both the 2006 and 2007 tables result from 

rounding of the monetary amounts to the nearest dollar. 

sulting services; chaired workshops; wrote reports, books and 

papers; and provided design work and construction supervision 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 purchased 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

Line item Applied Research Oak Crest 

Consolidated total 

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
(310) APPLIED RESEARCH ASSOCS., INC. v. COMMISSIONER 313

Line item Applied Research Oak Crest 

Consolidated total 

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: 

Line item Applied Research Oak Crest 

Consolidated total 

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 petitioner’s consolidated Federal income tax return was attributable 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 determined 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 constituted 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 prescribe 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 computation of an affiliated group’s tax liability shall be determined 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 determination of the consolidated net long-term capital gain and the consolidated 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

3Sec. 448 governs limitations on the use of the cash method of accounting. 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 compute 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, accounting, actuarial science, performing arts, or consulting (the function test) and 

(B) substantially all of the stock of the corporation, by value, is held directly, 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 

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 Corporations 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 certain modifications are made for any intercompany transactions 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 corporation, as defined in section 448(d)(2). 3
316 143 UNITED STATES TAX COURT REPORTS (310) 

the corporation; (iii) the estate of any individual described in the two previous 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 twoyear 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. 

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 computation 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 corporation for both years involved. Further, the parties agree that 

if examined as a separate entity, Oak Crest was not a qualified personal service corporation for the years involved. 
(310) APPLIED RESEARCH ASSOCS., INC. v. COMMISSIONER 317

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 corporation’s tax rate on the entire amount of income attributable to the 

qualified personal service corporation member without taking into consideration losses suffered by other members of the affiliated group. However, 

Continued 

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 taxable income of the group is to be split or broken up into separate 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 qualified personal service corporation. 

In contrast, petitioner asserts, in essence, that because the 

consolidated return regulations do not provide for the splitting 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 consolidated 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 petitioner’s taxable income is subject to the flat 35% rate. 5
318 143 UNITED STATES TAX COURT REPORTS (310) 

respondent states he took a ‘‘more conservative approach in this case to 

allow the members to net their income before applying the qualified personal service corporation tax rate’’. Because of respondent’s concession, we 

need not and do not consider netting losses against qualified personal service corporation income. 

III. Analysis 

The consolidated return regulations are intended to balance what this Court described in Norwest Corp. & Subs. v. 

Commissioner, 111 T.C. at 152, as ‘‘two countervailing principles 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. Commissioner, 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 consolidated 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 affiliated 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. 
(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 corporation 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 members. 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 illumination 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 taxable 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 affiliated 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 Specialty 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 position, 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 conceded that Applied Research and Oak Crest are permitted to 

net their incomes and expenses. 

Petitioner argues that the affiliated group must be examined 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 petitioner 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 envision 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 subsidiaries, 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 interplay 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 administrative 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 generated 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 discussed herein, and we find them to be either without merit, 

irrelevant, or moot. 

To reflect the foregoing, 

f 

Decision will be entered for petitioner.