Trip lets see if we can make you understand this. You may want to go to your edit categories page to see what I am talking about so this falls into place here. Your subcats and levels have nothing to do with anything.
Dining is the ONLY category that is a parent of other categories. It has CONTAINS THUMBS set to NO in the cats editor. All your other cats can contain images dining can not therefore this is how you get that bar. Now the only thing that is going to collapse when you click the collapse link on dining is the DIRECT SUBCATS beneath it.
I hope this clarifies this issue as I dont think I can say this any different that I already have in how it is suppose to operate and how it does operate. That site you link works fine just like mine here. http://www.reeftalk.com/gallery/index.php
Our gallery here is an even better example http://www.photopost.com/photopost/index.php