UNITED STATES TAX COURT



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
                                        -2-

      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 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
                                         -3-

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
                                        -4-

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

consulting 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

article 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

      1
       The parties stipulated that, when looked at as a separate entity, Applied
Research was a qualified personal service corporation. See infra p. 12. 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.
                                                                        (continued...)
                                       -5-

      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

                                                             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



      1
      (...continued)
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.
                                        -6-

Rents                       1,000                2,796                 3,796
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 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
                                         -7-

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 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, 

,

153 (1998); Woods Inv. Co. v. Commissioner, 

, 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:
                                  -8-

      (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));
                                       -9-

            (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 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 [Reg. §1.1502-2].

      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, 

, 209

(1984) (citing Bittker & Eustice, Federal Income Taxation of Corporations and

Shareholders, par. 15.20, at p. 15-51 (4th ed. 1979)). Sec. 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, 

;

see sec. 1.1502-12, Income Tax Regs.
                                        - 10 -

      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




      3
        Sec. 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 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 two-year
period beginning on the date of the death of that individual.
                                        - 11 -

      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

      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 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.
                                        - 12 -

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.

      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 to be split or
                                        - 13 -

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
                                           - 14 -

Research, a qualified personal service corporation, all of petitioner’s taxable

income is subject to the flat 35% rate.5

III.   Analysis

       The consolidated return regulations are intended to balance what this Court

described in Norwest Corp. & Subs. v. Commissioner, 

, 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, 

(quoting Handy & Hartman v. Burnet, 

, 140 (1931)). The contrasting second principle is that “‘[e]ach




       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, 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.
                                        - 15 -

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,

, 789 (1982) (quoting Elec. Sensing Prods., Inc. v. Commissioner, 

, 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.

      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.
                                         - 16 -

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
                                        - 17 -

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., 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
                                        - 18 -

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
                                        - 19 -

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 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, 

(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 the section 312(k) of the Code and section 1.1502-32, Income
                                        - 20 -

Tax Regs.; and that the Commissioner had failed to amend his regulations to

reflect his litigating position. Woods Inv. Co. v. Commissioner, 

.

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, 

, 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. 

(Drennen, J., concurring at page 633).

see also Gottesman & Co. v. Commissioner, 

, 1158 (1981)

(wherein we refused 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

characterization of the consolidated taxable income. And in this regard, the
                                        - 21 -

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,


                                                       Decision will be entered

                                                 for petitioner.