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Here are my thoughts:
1. I would not do an OIC on the taxpayer until the business is wound down and the assets disposed of. Otherwise it will become a fight over valuation and collectability. File a 433 to make him CNC while you wind down the company.
2. Is there any argument that can be made as to the issue of improper application of the amounts already paid? Not if it was made from the company’s accounts. If he made them personally (ie. voluntarily) and designated how they should be applied then yes, under Rev Proc 2002-26.
3. Argue for abatement of penalties during the Agreement Due Diligence / Lien Release period? Not sure there is reasonable cause here but you can try
4. Finally, (personally, I think it’s a longshot “probably not”, but I will ask it anyway) – since the business does have enough assets to cover the TFRP portion – can the taxpayer individually try for an OIC? Yes, see my answer to #1. Once the business and assets are gone then an OIC is on the table. Until then the IRS will insist on including the business, and the valuations of the assets will become an issue.
5. If I cannot get an acceptable resolution through Appeals, only other option is Bankruptcy? Bankruptcy does nothing. The taxes and the TFRP are non-dischargeable. Wind down the business, get rid of the assets, then do an OIC on him. All the bankruptcy does is invite in a Trustee to analyze what happened and perhaps chase him for any irregularities they disagree with. We generally never file a business bankruptcy, and an individual does nothing for him.
Hope that helps