                       T.C. Memo. 2008-38


                      UNITED STATES TAX COURT



          CLAUDE E. AND DANA L. SALAZAR, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent


                 CLAUDE E. SALAZAR, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket Nos. 2203-05L, 23547-06L.   Filed February 25, 2008.



     Jeremy H. Speich and Dana L. Salazar, for petitioners.

     Diana P. Hinton, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GOEKE, Judge:   These consolidated cases arise from petitions

for judicial review of two notices of determination concerning
                               - 2 -

collection action(s) under section 6320 and/or 6330.1   In

response to a notice of intent to levy issued by respondent with

respect to outstanding income tax liabilities, petitioners Claude

and Dana Salazar (Mr. and Mrs. Salazar) submitted an offer-in-

compromise for all of their outstanding tax liabilities, which

also included employment tax liabilities of Mr. Salazar.

Petitioners also sought abatement of penalties for the period

their bankruptcy petition was pending.   After Mr. Salazar

individually received a notice of intent to levy with respect to

his employment tax liabilities, Mr. Salazar submitted a second

offer-in-compromise and again challenged the assessment of

penalties and interest during the pendency of petitioners’

bankruptcy petition.   Respondent issued separate notices of

determination rejecting both offers-in-compromise and sustaining

the proposed collection actions.

     We have jurisdiction to review respondent’s collection

determination relating to the employment tax liabilities as well

as the income tax liabilities under amended section 6330(d)(1)

because respondent made his determination more than 60 days after

August 17, 2006.   See Callahan v. Commissioner, 130 T.C. __

(2008).   Respondent has now admitted to assessing a penalty

erroneously for petitioners’ 1997 income tax year while their


     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
                               - 3 -

bankruptcy petition was pending and has agreed to correct this

error.   Because we find respondent did not abuse his discretion

in rejecting petitioners’ offers-in-compromise, and because we

find that respondent did not otherwise erroneously assess

penalties and interest, we sustain respondent’s determinations.

                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulations of facts and related exhibits are incorporated

herein by this reference.   At the time the petitions were filed,

petitioners, husband and wife, resided in New York.

     Previously, petitioners were residents of Nevada, where they

owned and operated a retail art gallery named Artistic Nature.

While operated by both petitioners, the gallery was organized as

a sole proprietorship in the name of Mr. Salazar.    The operation,

and ultimately the failure, of Artistic Nature has led to the

current proceedings.   Respondent seeks collection of petitioners’

outstanding Federal income taxes, penalties, and interest for

taxable years 1997, 1998, and 1999.    Respondent also seeks to

collect the outstanding employment tax liabilities of Mr. Salazar

related to Artistic Nature from 1998 through 2001.

     On January 23, 2001, when Artistic Nature was failing,

petitioners filed for chapter 13 bankruptcy protection in the

U.S. Bankruptcy Court for the District of Nevada.    Petitioners

captioned their bankruptcy petition as “Claude E. Salazar dba
                                - 4 -

Artistic Nature and Dana Salazar dba Artistic Nature.”    The

petition was later converted to a chapter 7 proceeding.

     On February 1, 2001, respondent filed a proof of claim with

the bankruptcy court, which respondent later amended.    On

respondent’s last amendment to the proof of claim, filed on

September 27, 2003, respondent listed a secured claim of

$19,915.40, an unsecured priority claim of $43,673.45, and an

unsecured general claim of $8,850.74.    The secured claim related

to a lien respondent had previously filed with respect to

petitioners’ 1997 and 1998 income tax liabilities, and it

included penalties and interest.    The unsecured priority claim

also included interest.    Petitioners, while represented by

counsel, did not file an objection to respondent’s claims.      On

July 25, 2002, petitioners received a discharge of debtor from

all dischargeable debts.    On August 22, 2005, the bankruptcy

trustee disbursed $17,834.51 to respondent.    The bankruptcy case

was closed on March 30, 2006.

     During the 2000, 2001, and 2002 tax years, petitioners

allowed withholdings from income to exceed their income tax

liabilities, which created overpayments totaling $15,814.91.      On

October 2, 2003, respondent applied these overpayments to

petitioners’ 1997 income tax liabilities.    On October 6, 2003,

respondent assessed $3,192.34 in interest and an additional
                                - 5 -

$1,216.52 failure to file penalty for petitioners’ taxable period

ending December 31, 1997.

     After petitioners received the discharge of debtor,

respondent initiated collection on petitioners’ liabilities.   On

October 27, 2003, respondent sent petitioners a separate letter

for each of the outstanding liabilities stating that he intended

to seek collection by levy.    Respondent’s notification of intent

to levy indicated the following liabilities, including penalties

and interest:

          Tax From Form     Period Ending   Unpaid Balance


                1040         12/31/1997            $437.21
                1040         12/31/1998           5,923.33
                1040         12/31/1999           6,923.71
                941          12/31/1998           3,970.30
                941           3/31/1998           6,248.92
                941           6/30/1999           5,658.56
                941           9/30/1999           7,000.45
                941          12/31/1999           6,122.27
                941           3/31/2000           5,006.08
                941           6/30/2000           5,626.37
                941           9/30/2000           6,575.15
                941          12/31/2000           5,855.57
                941           3/31/2001           5,118.99
                941           6/30/2001           2,210.01
                               - 6 -

     On or about December 6, 2003, respondent issued a final

notice of intent to levy related to the income tax liabilities

for 1997, 1998, and 1999.   Respondent’s notice of intent to levy

did not include Mr. Salazar’s employment tax liabilities.     On

December 16, 2003, petitioners submitted a Form 12153, Request

for a Collection Due Process Hearing.   Notwithstanding the fact

the final notice of intent to levy pertained only to petitioners’

income tax liabilities, petitioners indicated they were seeking

collection review with respect to both their income and

employment tax liabilities.   Petitioners stated:   “We declared

Chapter 7 bankruptcy in January 2001.   Discharge was July 2001

[sic]--there were assets--the bankruptcy is still open pending

filing of final accounting report by the trustee.    Calls to IRS

and IRS bankruptcy Department have gone unanswered.”    Despite the

request for a collection review hearing, respondent issued the

levy.   Upon realizing that he should have suspended the proposed

levy action until after the hearing and any appeals, respondent

released the levy.   See sec. 6330(e)(1); Grover v. Commissioner,

T.C. Memo. 2007-176.

     Petitioners’ file was forwarded to Appeals Settlement

Officer Bruce Conte.   On May 14, 2004, Mr. Conte contacted

petitioners to schedule a conference.   At the same time, Mr.

Conte contacted respondent’s internal bankruptcy specialists.

Mr. Conte received a fax from a specialist outlining petitioners’
                                - 7 -

bankruptcy file and noting that “secured claims get paid first

and then priority.”    Mr. Conte noted in his case record that

there were also outstanding employment tax liabilities for

petitioners and that final collection notices had not yet been

issued with respect to those liabilities.

     On or about May 24, 2004, petitioners submitted a completed

Form 656, Offer in Compromise, to respondent seeking to resolve

their outstanding employment and income tax liabilities for

$9,024.25, to be paid within 90 days from notice of acceptance of

the offer.    Upon receipt of the offer-in-compromise, Mr. Conte

contacted petitioners to seek additional financial information.

Over the course of several months, Mr. Conte and petitioners

corresponded on multiple occasions with respect to additional

documents Mr. Conte needed in evaluating petitioners’ offer-in-

compromise.    In one letter to Mr. Conte dated August 13, 2004,

petitioners requested that “given that the Bankruptcy Court has

failed to render a final accounting to date, the penalties

attributable to the principal balance outstanding should be

waived.”

     While he was attempting to obtain additional information

about petitioners’ economic situation, Mr. Conte was also

attempting to determine what amount would be paid to respondent

from petitioners’ bankruptcy estate.    Mr. Conte contacted

respondent’s internal bankruptcy specialists on numerous
                                 - 8 -

occasions.     Following one such contact, Mr. Conte received an e-

mail informing him that “Mr. Salazar owes: IMF $13,977.92 and BMF

$62,786.01 for a total of $76,763.93.     The amount that will come

to IRS from the trustee’s office * * * [$25,000 less trustee

expenses] will not full-pay the account (less than 1/3 of balance

due).     Collection will not be withheld.”2

         According to his case record, Mr. Conte was concerned that

accepting an offer-in-compromise while awaiting a final

distribution from the bankruptcy might jeopardize respondent’s

claims to that distribution.     Mr. Conte performed research,

including reviewing the Internal Revenue Manual (IRM), to assist

with his consideration of petitioners’ offer-in-compromise.      Mr.

Conte noted the IRM’s caution on accepting an offer-in-compromise

while awaiting a distribution of assets from a bankruptcy.       Mr.

Conte also sought and received legal advice on the effect an

offer-in-compromise would have on the pending bankruptcy

distribution.     Counsel from within the Internal Revenue Service

(IRS) advised Mr. Conte that acceptance of the offer-in-

compromise risked respondent’s claim to the distribution and that

the offer-in-compromise should be increased by the amount

respondent expected to receive from the bankruptcy.



     2
      “IMF” refers to respondent’s Individual Master File for
petitioners’ income tax liabilities. “BMF” refers to
respondent’s Business Master File for Mr. Salazar’s employment
tax liabilities.
                               - 9 -

     After receiving counsel’s advice, on November 8, 2004, Mr.

Conte sent petitioners a letter informing them that--

     I have received guidance from our Counsel regarding the
     acceptance of an Offer in Compromise in an instance
     where the distribution of the assets of the bankruptcy
     has not been completed. This, as you may recall, was
     the primary issue surrounding your * * * request for an
     offer.

     It is Counsel’s opinion, as it is mine, that if the
     Service were to accept an offer in this instance, the
     Service would at that point no longer have a claim to
     any distribution of the bankruptcy proceeds.

     It is also our opinion that the only way that an offer
     could be accepted under these circumstances, is for the
     Service to attempt to determine how much of the
     distribution we would be entitled to and add that to
     the amount of the offer.

Mr. Conte went on to reason that respondent would likely receive

approximately $20,000 from the pending distribution.

Accordingly, Mr. Conte informed petitioners that their offer-in-

compromise would have to be increased by $20,000 before it could

be accepted.

     By letter dated November 22, 2004, petitioners responded

that they could not pay the estimated $20,000 to respondent that

was pending distribution without first receiving the

distribution.   As an alternative, petitioners offered to

relinquish any rights they might have to the distribution for the

benefit of respondent.   Mr. Conte determined that this offer-in-

compromise still risked respondent’s forthcoming distribution and

thus could not be accepted before receipt of the distribution
                               - 10 -

from the bankruptcy estate.   As part of his analysis in his

closing memorandum, Mr. Conte noted that if the offer-in-

compromise were accepted, any funds remaining after the

bankruptcy trustee discharged petitioners’ debts would go to

other creditors or to petitioners.      Mr. Conte concluded:   “Based

upon informal advice from Counsel and the taxpayer’s response, it

is Appeals’ decision to reject the offer-in-compromise of

$9,024.25 as insufficient due to the fact that a larger amount

appears to be collectible.”

     On January 4, 2005, respondent’s Appeals Office issued a

Notice of Determination Concerning Collection Action(s) Under

Section 6320 and/or 6330 sustaining the proposed levy action with

respect to petitioners’ 1997, 1998, and 1999 income tax

liabilities.    In a separate letter addressed only to Mr. Salazar,

Mr. Conte indicated that the offer-in-compromise had also been

rejected with respect to his outstanding employment tax

liabilities.

     On February 3, 2005, petitioners filed a petition with this

Court seeking review of respondent’s determination under docket

No. 2203-05L.   Petitioners allege that respondent’s rejection of

their offer to compromise both their outstanding income tax

liabilities and Mr. Salazar’s employment tax liabilities was an

abuse of discretion.   Petitioners’ petition for docket No. 2203-
                              - 11 -

05L did not seek to challenge the underlying income tax

liabilities that respondent was seeking to collect.

     Respondent moved to dismiss for lack of jurisdiction as to

Mr. Salazar’s employment tax liabilities on the grounds that

respondent had never issued a notice of determination concerning

a collection action under section 6330 with respect to the

employment tax liabilities.   In a Salazar v. Commissioner, T.C.

Memo. 2006-7, filed January 18, 2006, we found that no notice of

determination for purposes of section 6330 had been issued with

respect to petitioners’ employment tax liabilities and granted

respondent’s motion to dismiss for lack of jurisdiction with

respect to Mr. Salazar’s employment tax liabilities.3

     In the interim, on June 20, 2005, the bankruptcy trustee

submitted to the bankruptcy court a Trustee’s Final Report and

Application for Compensation and Reimbursement (the final

report).   In the final report, payment on respondent’s secured

claim of $19,915.40 was not allowed.   Instead, payment on

respondent’s priority claim of $43,673.45 was allowed.    On August

22, 2005, the bankruptcy trustee disbursed $17,834.51 to

respondent.


     3
      Respondent also moved to dismiss on the grounds that the
Court lacked jurisdiction to hear any challenge to Mr. Salazar’s
employment tax liabilities. However, because respondent issued a
notice of determination with respect to Mr. Salazar’s employment
tax liabilities on Oct. 18, 2006, respondent admits that we now
have jurisdiction to review his determination under sec.
6330(d)(1). See Callahan v. Commissioner, 130 T.C. __ (2008).
                               - 12 -

     On August 25, 2005, respondent applied the proceeds of the

bankruptcy distribution to Mr. Salazar’s outstanding employment

tax liabilities for the taxable periods ending December 31, 1998,

March 31, 1999, and June 30, 1999.      However, the amounts that

respondent applied to these taxable periods exceeded the priority

claims for those periods.    On April 24, 2007, respondent adjusted

the application of the bankruptcy proceeds to also include

partial payments for the taxable periods ending September 30,

1999, as well as December 31, 1999.

     As of June 30, 2005, Mr. Salazar still had unpaid employment

tax liabilities that included:

                Period Ending    Unpaid Balance


                   12/31/98              $2,636.81
                   3/31/99                5,281.02
                   6/30/99                4,067.44
                   9/30/99                5,904.60
                   12/31/99               5,158.55
                   3/31/00                4,219.10
                   6/30/00                4,729.82
                   9/30/00                5,522.11
                   12/31/00               4,670.33
                   3/31/01                4,097.97
                   6/30/01                1,752.20
                               - 13 -

     On February 22, 2006, respondent issued a Final Notice of

Intent to Levy and Notice of Your Right to a Hearing with respect

to Mr. Salazar’s employment tax liabilities.4   In response, Mr.

Salazar submitted a second Form 12153 with respect to the

proposed collection action on the employment tax liabilities.

The new request for collection review was assigned to Appeals

Settlement Officer Thomas Conley.    In his initial correspondence

with Mr. Conley, Mr. Salazar indicated that he did not intend to

submit a new offer-in-compromise but instead sought

reconsideration of petitioners’ original offer-in-compromise of

$9,024.25.    Mr. Salazar also attempted to challenge the

assessment of penalties and interest during the pendency of

petitioners’ bankruptcy as well as the manner in which respondent

applied the bankruptcy proceeds.

     On May 17, 2006, petitioners had an in-person hearing with

Mr. Conley.    On June 20, 2006, Mr. Salazar submitted a new offer-

in-compromise.    The basis of the new offer-in-compromise was

again doubt as to collectibility, and the new offer included

updated financial information.    Mr. Salazar offered to compromise

petitioners’ then-outstanding income and employment tax

liabilities for $19,547.13.    By this time, Mrs. Salazar was

working as an attorney and Mr. Salazar as a manager of a



     4
       Respondent’s notice of intent to levy did not include the
periods ending Dec. 31, 1998, or Mar. 31, 1999.
                              - 14 -

restaurant.   Mr. Salazar had also begun collecting monthly Social

Security benefits.   Mr. Conley determined that petitioners’

reasonable collection potential exceeded the outstanding

liabilities and thus rejected the offer-in-compromise.     Mr.

Conley’s determination did not, however, address Mr. Salazar’s

claims that respondent was seeking to collect penalties and

interest assessed for the period while petitioners’ bankruptcy

petition was pending.

     On October 18, 2006, respondent issued a Notice of

Determination and Collection Action Under Section 6320 and/or

6330 to Mr. Salazar regarding his employment tax liabilities.

Mr. Salazar then filed a second petition to this Court claiming

error in respondent’s determination to proceed with collection in

the case at docket No. 23547-06L.   The second petition does not

allege any error with respect to respondent’s rejection of Mr.

Salazar’s second offer-in-compromise.   Instead, Mr. Salazar again

alleges that respondent abused his discretion in failing to

revisit and accept petitioners’ original 2004 offer-in-

compromise.   Mr. Salazar also alleges error by respondent in not

abating the penalties and interest assessed for the period while

petitioners’ bankruptcy petition was pending.   Finally, Mr.

Salazar alleges that it was an error for respondent to apply the

bankruptcy proceeds to his individual employment tax liabilities

instead of petitioners’ joint income tax liabilities.     The two
                              - 15 -

petitions have been consolidated for trial, briefing, and

opinion.

                              OPINION

I.   Introduction

     While this matter has developed in a manner that has made it

more complicated than necessary, in the end it is a collection

review case in which petitioners principally sought to resolve

their outstanding income and employment tax liabilities through

an offer-in-compromise.   Petitioners offered to settle all of

their outstanding liabilities, including the income tax

liabilities and the employment tax liabilities, for $9,024.25.

Respondent rejected the offer-in-compromise because he was likely

to receive more from the petitioners’ pending bankruptcy.

Petitioners want the Court to determine that respondent’s

rejection was an abuse of discretion and that respondent be

compelled to accept the offer-in-compromise with respect to both

the income taxes and the employment taxes.   We find that

respondent did not abuse his discretion.

     Section 6330 provides that no levy may be made on any

property or right to property of a person unless the Secretary

first notifies him in writing of the right to a hearing before

the Appeals Office.   At the hearing, the taxpayer may raise any

relevant issues relating to the unpaid tax or the proposed levy,

including appropriate spousal defenses, challenges to the
                                - 16 -

appropriateness of collection actions, and collection

alternatives.   Sec. 6330(c)(2)(A).      A taxpayer may contest the

existence or amount of the underlying tax liability if the

taxpayer failed to receive a notice of deficiency for the tax

liability in question or did not otherwise have an earlier

opportunity to dispute the tax liability.       Sec. 6330(c)(2)(B);

see also Sego v. Commissioner, 114 T.C. 604, 609 (2000).

      Following a hearing, the Appeals Office must make a

determination whether the Secretary may proceed with the proposed

collection action.   We have jurisdiction to review the Appeals

officer’s determination.     Sec. 6330(d)(1).    Where the underlying

tax liability is properly at issue, we review that determination

de novo.   Goza v. Commissioner, 114 T.C. 176, 181-182 (2000).

Where the underlying tax liability is not at issue, we review the

determination for an abuse of discretion.       Id. at 182.

II.   Offers-in-Compromise

      Petitioners first seek to compel respondent’s acceptance of

their offer-in-compromise.     Petitioners suggest that the failure

to accept their original offer-in-compromise was an abuse of

discretion.

      We do not conduct an independent review of what would be an

acceptable offer-in-compromise.     Murphy v. Commissioner, 125 T.C.

301, 320 (2005), affd. 469 F.3d 27 (1st Cir. 2006); Fowler v.

Commissioner, T.C. Memo. 2004-163.       The extent of our review is
                                - 17 -

to determine whether the Appeals officer’s decision to reject the

taxpayer’s offer-in-compromise was arbitrary, capricious, or

without sound basis in fact or law. Skrizowski v. Commissioner,

T.C. Memo. 2004-229; Fowler v. Commissioner, supra.

        Section 7122(a) authorizes the Commissioner to compromise

any civil or criminal case arising under the internal revenue

laws.     See Fargo v. Commissioner, 447 F.3d 706, 712 (9th Cir.

2006) (noting that the authorization to compromise any civil or

criminal case is discretionary), affg. T.C. Memo. 2004-13.

Section 7122(c) provides that the Commissioner shall prescribe

guidelines for evaluation of whether an offer-in-compromise

should be accepted.     See sec. 301.7122-1(c)(1), Proced. & Admin.

Regs.

     The section 7122 regulations set forth grounds for the

compromise of a taxpayer’s liability, including doubt as to

collectibility.     Sec. 301.7122-1(b), Proced. & Admin. Regs.

Doubt as to collectibility exists in any case where the

taxpayer’s assets and income are less than the full amount of the

liability.     Sec. 301.7122-1(b)(2), Proced. & Admin. Regs.

Generally, under the Commissioner’s administrative

pronouncements, an offer to compromise based on doubt as to

collectibility will be acceptable only if it reflects the

reasonable collection potential of the case; i.e., that amount,

less than the full liability, that the IRS could collect through
                                - 18 -

means such as administrative and judicial collection remedies.

Rev. Proc. 2003-71, sec. 4.02(2), 2003-2 C.B. 517, 517.     The

offer-in-compromise must include all unpaid tax liabilities and

periods for which the taxpayer is liable.     1 Administration, IRM

(CCH), pt. 5.8.1.7, at 16,256.

     If an offer-in-compromise is submitted where a taxpayer has

also filed a bankruptcy petition, the Commissioner cautions

against acceptance of the offer-in-compromise in the window

between a taxpayer’s discharge in bankruptcy and the time the

final distribution is made because “it is uncertain whether the

Service would still have a valid claim in bankruptcy if an offer

is accepted.”    1 Administration, IRM (CCH), pt. 5.8.10.2.3(2), at

16,368.   Thus, the Internal Revenue Manual guidelines advise that

“the amount acceptable for an offer should include the amount we

reasonably expect to recover from the bankruptcy in addition to

what can be collected from the taxpayer on non-discharged

liabilities or from property outside the bankruptcy.”     Id.

     It is clear from the administrative record that Mr. Conte

was concerned that accepting petitioners’ $9,024.25 offer-in-

compromise would risk respondent’s expected distribution from the

bankruptcy.     Mr. Conte had extended contact with respondent’s

bankruptcy specialists.     He also performed his own research,

including reviewing the IRM guidelines.     Mr. Conte sought to

determine the likely amount respondent would receive from the
                              - 19 -

bankruptcy and the effect accepting a compromise would have on

respondent’s distribution.   Ultimately, Mr. Conte concluded that

respondent was likely to receive approximately $20,000 of the

$25,000 remaining in the bankruptcy.   Further, as advised by

counsel, Mr. Conte concluded that accepting the offer-in-

compromise risked respondent’s claims in the bankruptcy estate.

Thus, in accordance with the IRM and advice from counsel, Mr.

Conte determined that petitioners’ offer-in-compromise was

inadequate because it was less than what respondent expected to

receive from the bankruptcy trustee and because accepting that

offer would place that distribution at risk.

     Petitioners argue that respondent’s rejection of the offer-

in-compromise was based on an erroneous conclusion of law that

the bankruptcy distribution was at risk.   Petitioners argue that

respondent’s distribution from the bankruptcy was never at risk.

If respondent’s determination was based upon an erroneous

conclusion of law, we must reject that view and find that

respondent abused his discretion.   See Swanson v. Commissioner,

121 T.C. 111, 119 (2003).

     As respondent’s counsel now explains, an offer-in-compromise

must include all of the outstanding liabilities of the taxpayer.

Further, section 6325(a) provides that the Commissioner “shall

issue a certificate of release of any lien imposed with respect

to any internal revenue tax” not later than 30 days after the
                              - 20 -

liability for the amount has been fully satisfied.    Thus

respondent argues, if respondent were to accept an offer-in-

compromise and the liabilities were thereby fully satisfied, he

would jeopardize any secured claim to the bankruptcy

distribution.   Accordingly, as respondent’s counsel argues, an

offer-in-compromise will not be accepted while a bankruptcy is

pending if the offer is less than the amount he reasonably stands

to receive when the bankruptcy distribution occurs.

     We believe, however, that respondent’s risk, or at least his

perceived risk, goes beyond simply the release of any secured

claim he has to the bankruptcy distribution.   If an offer-in-

compromise must include all of the outstanding liabilities of the

taxpayer, then acceptance and satisfaction of the offer would

risk, if not extinguish, all claims the Commissioner had to the

bankruptcy assets.   The administrative record suggests it was

this more generalized risk, to all of respondent’s claims, that

concerned Mr. Conte in evaluating petitioners’ offer-in-

compromise.   Nonetheless, petitioners fail to point to any

authority to suggest that respondent’s position that accepting an

offer-in-compromise jeopardized the bankruptcy distribution was

without legal basis, and the Court knows of none.

     In furtherance of their argument that the bankruptcy

distribution was not at risk, petitioners highlight their offer

to relinquish any claim to the bankruptcy distribution for the
                               - 21 -

benefit of respondent.    While this offer would have reduced the

risk that petitioners would receive a windfall from the

bankruptcy by virtue of the offer-in-compromise, it did nothing

to reduce respondent’s risk with respect to other creditors.      As

Mr. Conte explained in his closing memorandum:    if the offer-in-

compromise were accepted, any remaining funds in the bankruptcy

“would go to other creditors or to the taxpayer.”    Petitioners

again fail to present any authority to suggest that their other

creditors would be precluded from objecting to any distribution

to respondent after the acceptance of their offer-in-compromise.

     Petitioners make two additional arguments on why

respondent’s determination was an abuse of discretion.    First,

petitioners suggest that respondent was announcing a bright-line

rule and did not exercise discretion at all.    Second, petitioners

argue that respondent abused his discretion because he rejected

the offer-in-compromise solely on the basis of the amount offered

in contravention of section 7122(d)(3).    We address each in turn.

     Petitioners first take issue with Mr. Conte’s requirement

that their offer-in-compromise be increased by the amount of the

expected distribution from the bankruptcy.    The IRM guidelines

instruct that an acceptable offer-in-compromise would have to

include the amount that respondent expected to receive from the

bankruptcy in addition to what respondent could collect from

petitioners directly.    Petitioners argue that by relying upon
                              - 22 -

this provision of the IRM, the Appeals officer was not exercising

discretion at all but instead enunciating a bright-line rule for

all postdischarge bankruptcy cases where the Commissioner is

waiting for a distribution.   See Estate of Roski v. Commissioner,

128 T.C. 113 (2007) (holding that by requiring all estates to

post a bond to make a section 6166 election regardless of the

facts before him, the Commissioner was adopting a bright-line

policy that trumped the exercise of his discretion).

     Mr. Conte’s use of the IRM was not, however, a de facto

enunciation of a bright-line rule that trumped the exercise of

discretion.   In evaluating an offer-in-compromise under doubt as

to collectibility, the Commissioner must first determine the

reasonable collection potential on the amount owed.    Rev. Proc.

2003-71, sec. 4.02(2).   In the ordinary circumstance, the

Commissioner calculates the reasonable collection potential by

determining the excess of a taxpayer’s assets and future income

above certain allowances for basic living expenses.    See Klein v.

Commissioner, T.C. Memo. 2007-325.     The guidelines aid the

Commissioner in this endeavor.   Id.; see also, e.g., McDonough v.

Commissioner, T.C. Memo. 2006-234; Etkin v. Commissioner, T.C.

Memo. 2005-245; Schulman v. Commissioner, T.C. Memo. 2002-129.      A

pending bankruptcy petition changes this collection analysis

because the taxpayer has surrendered his assets to the bankruptcy

court.   Thus, where a taxpayer has filed for bankruptcy, the
                               - 23 -

Commissioner stands to collect as a creditor in the bankruptcy

proceeding in addition to possibly collecting from the taxpayer

directly from future income and assets not subject to the

bankruptcy.

     Thus, at first, the IRM instructs a settlement officer to

consider the Commissioner’s standing as a creditor in the

bankruptcy and advises that an acceptable offer-in-compromise

include the amount the Commissioner reasonably expects to recover

from the bankruptcy.    1 Administration, IRM (CCH), pt.

5.8.10.2.3(2).   In other words, the Appeals officer should not

accept an offer of $5 when doing so will risk the likely receipt

of $10 down the road.   Second, the IRM instructs that an

acceptable offer-in-compromise should also include the amount

that “can be collected from the taxpayer on non-discharged

liabilities or from property outside the bankruptcy.”      Id.   Thus,

if the Commissioner stands to receive $10 as a creditor in the

bankruptcy and, in addition, $5 can be collected directly from

the taxpayer, then the reasonable collection potential is not $5

or even $10, but more like $15.

     Mr. Conte did not have to reach the second part of this

analysis––the amount respondent could collect from petitioners

outside of the bankruptcy.    The $9,024.25 offer-in-compromise

from petitioners was less than the $20,000 Mr. Conte expected

respondent would receive from the bankruptcy, and he determined
                               - 24 -

that acceptance of the offer would risk the receipt of that

$20,000.    We find that Mr. Conte was not enunciating a bright-

line rule for all cases.    Mr. Conte was simply applying

respondent’s guidelines on evaluating offers-in-compromise,

including the reasonable collection potential, to the specifics

of petitioners’ offer.

     Finally, petitioners argue that respondent abused his

discretion by rejecting petitioners’ offer-in-compromise solely

on the basis of the amount offered.     Section 7122(d)(3)(A)

provides:    “an officer or employee of the Internal Revenue

Service shall not reject an offer-in-compromise from a low-income

taxpayer solely on the basis of the amount of the offer”.       The

regulations expand on this by stating that “No offer to

compromise may be rejected solely on the basis of the amount of

the offer without evaluating that offer under the provisions of

this section and the Secretary's policies and procedures

regarding the compromise of cases.”     Sec. 301.7122-1(f)(3),

Proced. & Admin. Regs.

     The administrative record makes clear that Mr. Conte did not

reject petitioners’ offer-in-compromise solely on the basis of

the amount offered, $9,024.25.    Mr. Conte used respondent’s

policies and procedures––the guidelines of the IRM as well as

advice received from counsel––to evaluate the specifics of

petitioners’ offer in the light of what respondent could
                              - 25 -

reasonably expect to collect on petitioners’ liabilities.     Mr.

Conte concluded that respondent was likely to receive more in the

distribution from the bankruptcy than from petitioners’ offer-in-

compromise.   Further, Mr. Conte determined that accepting

petitioners’ offer would risk this expected greater distribution.

We find petitioners’ offer-in-compromise was not rejected solely

on the basis of the amount offered.

     We are not unsympathetic to petitioners’ situation as they

ultimately had no control over when any distribution from the

bankruptcy would be made.   Since then, petitioners’ financial

outlook has improved dramatically.     Mr. Salazar is now employed

as a manager of a restaurant and has begun receiving Social

Security benefits.   Mrs. Salazar completed law school and now

works as an attorney.   Thus, while the $9,024.25 offer-in-

compromise may have been the limit of what petitioners could pay

in 2004, when Mr. Salazar submitted a second offer-in-compromise

during the second collection review hearing with respect to his

employment tax liabilities, respondent determined that Mr.

Salazar was then in a position to pay the entirety of his

outstanding employment tax liabilities.    Petitioners have not

presented any argument or evidence to the Court to suggest that

respondent’s rejection of this second offer-in-compromise was an

abuse of discretion.
                              - 26 -

     In sum, we find that respondent did not abuse his discretion

in rejecting petitioners’ offers-in-compromise.

III. Underlying Liability

     To the extent the Court does not compel respondent to accept

their original offer-in-compromise, petitioners argue in the

alternative that respondent’s assessment of penalties and

interest while their bankruptcy petition was pending was

erroneous.   Petitioners also argue that respondent erroneously

applied the bankruptcy proceeds to the individual employment tax

liabilities of Claude Salazar instead of their joint income tax

liabilities.

     In a collection review proceeding, a taxpayer may raise

challenges to the existence or amount of the underlying liability

for any tax period if the person did not receive any statutory

notice of deficiency for such tax liability or did not otherwise

have an opportunity to dispute the underlying liability.    Sec.

6330(c)(2)(B).   Where a taxpayer has filed a bankruptcy action,

and the Commissioner has submitted a proof of claim for unpaid

Federal tax liabilities in a taxpayer’s bankruptcy action, we

have held that the taxpayer has had the opportunity to dispute

the liabilities for purposes of section 6330(c)(2)(B).    See

Kendricks v. Commissioner, 124 T.C. 69 (2005); Sabath v.

Commissioner, T.C. Memo. 2005-222.     A bankruptcy court may

consider the amount or legality of taxes, including penalties and
                              - 27 -

interest.   11 U.S.C. sec. 505(a) (2000); Sabath v. Commissioner,

supra.

     In petitioners’ bankruptcy proceeding, respondent submitted

a proof of claim for petitioners’ unpaid income tax and

employment tax liabilities, including penalties and interest.

Petitioners, while represented by counsel, did not file an

objection to these tax liabilities.    Accordingly, petitioners are

precluded from challenging their underlying liabilities,

including the penalties and interest.    However, even if

petitioners had raised the issue of whether respondent’s

assessment of penalties and interest during their bankruptcy

proceeding was erroneous, to the extent that respondent has not

conceded this issue, we would sustain his assessment of penalties

and interest.

     Section 6658(a) provides that “No addition to the tax shall

be made under section 6651, 6654, or 6655 for failure to make

timely payment of tax with respect to a period during which a

case is pending under title 11 of the United States Code”.

Petitioners’ bankruptcy was pending from the date they filed

their petition until their case was closed on March 30, 2006.

See Rev. Rul. 2005-9, 2005-1 C.B. 470.

     Respondent admits having erroneously assessed a failure to

pay penalty with respect to petitioners’ 1997 income tax account

on October 23, 2003, while petitioners’ bankruptcy was pending.
                                - 28 -

Respondent has agreed to correct this error.   Petitioners did not

present any evidence that respondent assessed penalties for their

1998 and 1999 income tax liabilities while their bankruptcy

petition was pending.   Further, a review of petitioners’ income

tax account transcripts for 1998 and 1999 confirms that

respondent did not assess any additional penalty during the

pendency of their bankruptcy.

     With respect to the employment tax liabilities for Mr.

Salazar under docket No. 23547-06L, petitioners again argue that

additions to tax were sought for the period their bankruptcy was

pending.   However, section 6658 does not prevent respondent from

assessing the additions to tax during the pendency of the

bankruptcy related to employment taxes to the extent that they

are withheld or collected from others.   Sec. 6658(b); Kiesner v.

IRS, 194 Bankr. 452, 458 (Bankr. E.D. Wis. 1996); see also S.

Rept. 96-1035, at 51 (1980), 1980-2 C.B. 620, 646 (“These relief

rules do not, however, apply with respect to liability for

penalties for failure to timely pay or deposit any employment tax

required to be withheld by the debtor or trustee.”).

Accordingly, we find no basis to suggest that the employment tax

liabilities respondent seeks to collect include any erroneously

assessed additions to tax.

     Petitioners also argue for abatement of interest on both

their income tax and employment tax liabilities.   The
                              - 29 -

Commissioner is not prevented from seeking interest for the

period a taxpayer’s bankruptcy proceeding is pending.    Sec.

6658(a); see also, e.g., Woodward v. United States, 113 Bankr.

680, 684 (Bankr. D. Or. 1990).    Under section 6404(a), the

Commissioner is granted the discretion to abate the assessment of

any tax or liability that is excessive in amount, assessed after

the expiration of the period of limitation, or erroneously

assessed.   But see sec. 6404(b) (“No claim for abatement shall be

filed by a taxpayer in respect of an assessment of any tax

imposed under subtitle A or B.”).    Section 6404(e) authorizes the

Commissioner to abate interest assessments that are attributable

to errors or delays by the IRS.

     Petitioners do not argue that the interest is excessive or

was erroneously assessed under section 6404(a).    Instead,

petitioners argue for abatement of interest because of the delay

in the distribution of funds from the bankruptcy.    While in

certain circumstances interest may be abated because of an

unreasonable delay of the Commissioner, respondent was no more in

control over the distribution of the bankruptcy proceeds than

were petitioners.   We find that the delay in the distribution of

proceeds by the bankruptcy trustee is not grounds for the

abatement of interest under section 6404 or for otherwise

relieving petitioners from liability for the interest.
                               - 30 -

     Finally, under docket No. 23547-06L,5 petitioners challenge

respondent’s application of the bankruptcy proceeds to the

employment tax liabilities of Mr. Salazar instead of the joint

tax liabilities of both petitioners.    Because the distribution

occurred after the bankruptcy proceeding was closed, and Mr.

Salazar raised it during the hearing, we may review this issue.

     At the time of the bankruptcy trustee’s final report,

respondent possessed: (1) A secured claim of $19,915.40 for

petitioners’ 1997 and 1998 tax liabilities; (2) an unsecured

priority claim of $43,673.45 for petitioners’ 1999 income tax

liabilities and Mr. Salazar’s 1998, 1999, 2000, and 2001

employment tax liabilities; and (3) an unsecured general claim of

$8,850.74.   However, only payment on respondent’s $43,673.45

priority claim was allowed by the bankruptcy trustee.

     Respondent applied the $17,834.51 that was ultimately

disbursed by the bankruptcy trustee on August 22, 2005, to the

employment tax liabilities of Mr. Salazar that made up part of

respondent’s priority claim.   At first respondent applied the

disbursement to the employment tax periods ending December 31,

1998, March 31, 1999, and June 30, 1999, in amounts that exceeded

respondent’s priority claims for those periods.    Eventually,

respondent corrected this application of the proceeds to also


     5
      The trustee had not filed his final report nor had any
disbursements been made at the time of petitioners’ collection
review hearing with respect to their joint liabilities.
                              - 31 -

include partial payments on the priority claims for the periods

ending September 30, 1999, and December 31, 1999.

     Petitioners claim that respondent should have applied the

disbursement to petitioners’ joint income tax liabilities first

instead of just Mr. Salazar’s employment tax liabilities.    Where

a taxpayer makes voluntary payments to the IRS, he does have the

right to direct the application of payments to whatever type of

liability he chooses.   See, e.g., Estate of Wilson v.

Commissioner, T.C. Memo. 1999-221.     However, where a taxpayer

makes an involuntary payment, the IRS may allocate or reallocate

the payment as it sees fit, regardless of a taxpayer’s

designation.   As we have stated:   “An involuntary payment of

Federal taxes means any payment received by agents of the United

States as a result of distraint or levy or from a legal

proceeding in which the Government is seeking to collect its

delinquent taxes or file a claim therefor.”     Amos v.

Commissioner, 47 T.C. 65, 69 (1966); see also United States v.

Pepperman, 976 F.2d 123, 127 (3d Cir. 1992) (noting that most

courts to have considered the issue have concluded that payments

made in the bankruptcy context are involuntary).    In the light of

the involuntary nature of the bankruptcy distribution, we find no

error in respondent’s application of the proceeds to the

employment tax liabilities of Mr. Salazar before the joint income

tax liabilities of both petitioners.    In any event, there is no
                             - 32 -

evidence that petitioners specified in writing that the proceeds

be applied to their income tax liability instead.

     On the basis of the record before the Court, and with the

exception of the failure to pay penalty for income tax year 1997

which respondent concedes, petitioners are liable for the taxes,

additions to tax, and interest as determined by respondent.    We

further find that respondent did not abuse his discretion in

rejecting petitioners’ offers-in-compromise.   Thus, respondent's

determination that the Federal tax levies were appropriate in

these cases is sustained.

     To reflect the foregoing,



                                        Decision in docket No.

                                   2203-05L will be entered under

                                   Rule 155.

                                        Decision in docket No.

                                   23547-06L will be entered for

                                   respondent.
