My wife cashed in on some stocks that her mother left her after she
died.Because of her divorce of her first marriage she was left with
four kids and no child support to raise them. So the money came at the
right time to help her through.When she cashed in the stocks she
didn't pay the taxes on the money at that time so when tax time rolled
around she didn't have the money to pay the taxes. She was left with a
17,000 dollar debt on a 37,000 dollar payout.Since then she has payed
on the debt through her tax return which equals to about 15,000
dollars. The IRS says she still owes 17,000 because of penelties.What
can we do to settle this? Can we have the penalties removed? Is there
a resonable settlement based on the cirumstances?

The best and least expensive approach is to go directly to the
Taxpayer Advocate Office website at
http://www.irs.gov/advocate/display/0,,i1%3D55&genericId%3D13272,00.html

This is a remarkable service that is solely concerned with helping
taxpayers with their tax problems including trying to sort out the
messes of penalties and possible incorrect computations(happens all
the time).

There will be a form that you can download, print and mail.

It's free and the people at the TAO are very dedicated to helping the
taxpayers resolve all problems.

I used them a couple of years ago and was very happy with their
efforts and their friendly hard working staff.

By the way, the IRS claimed my wife owed them a few thousand as well. 
After the Taxpayer Advocate Office investigated, recomputed and
concluded the case, my wife ended up with a refund!  I hope the same
for you, but at the very least they will be able to put you at ease
that everything possible has been done for you with your tax issues.
We incurred no expense for accountants or tax lawyers....just the
price of a stamp to mail the form to the TAO.

The feeling I got was that finally...there is a government office that
really cares about us and works hard to achieve fair solutions.  You
will not be disappointed even if there is no tax or penalty reduction
because you'll be assured of getting top notch assistance.  I'd
contact the TAO again and quickly if I ever had any muddled disputes
with the IRS.

You might start by having an accountant double-check the amount of tax
your wife should have paid.
If she inherited the stock, then her 'basis' is what the stocks were
worth in the year her mother died, and the tax (at capital gains
rates) only applies to the increase in value from that date to the
date of sale.  The capital gains rate might be 15% or 20% depending on
your other income.
So for example, if the stocks were worth say 20,000 when she inherited
them and she sold them for 37,000, her gain was 17,000 and her tax
should have been about 3,000.

If the IRS is basing its tax, penalty and interest claim on a bigger
number, a good first step would be to check their calculation.