The IRS and the state will eventually figure out that you havent filed personal and or business returns and they will send you a notice. If you dont respond they will keep notifying you by mail and eventually via certified mail. Once you do file, you will need to set up a payment plan as soon as possible in order to avoid a levy against your wages and or bank account and tangible assets like your home. You need to do everything you can to avoid that. You may not want your employer to know your wages are being levied and levies against your home and other tangible assets are I believe are a matter of public record.
You dont say what type of business this is, the structure of the business, if it is an LLC, Sole Proprietorship, S Corporation, Incorporated, etc. or whether you had sales subject to sales tax, or if you had any employees (it doesnt sound like you did, I hope not as that is another problem, but if you did and didnt file 941s and W-2s the IRS would have caught up with you before now) but if you did, you will need to clean those up as well. The legal structure of the business will determine if the profits and losses are filed on your personal tax returns or on a separate business tax return.
I know it is overwhelming especially since it sounds like your wife didnt keep good records, but you need to get what you have and get it organized. Start with the business checkbook. If you didnt use any accounting software, something like QuickBooks, put all the receipts (business income) and expenses into a simple spreadsheet by year. You may be able to find Excel spreadsheet templates on line for free.
Also go through your personal checkbook and credit card statements and identify any legitimate business expenses paid via those. Start by just putting whatever receipts and records you have in piles by year, then organizing them by categories of expenses as best you can. Also make sure you include your IRA early withdrawals, you should have received a statement from them and will be able to determine if they withheld taxes and an early withdrawal penalty from the net payment. Some expense will be deductible, some will not or some only partially but you need to identify them all and take whatever deductions you are legitimately entitled to take. If the business had legitimate losses, then that may mean you wont have tax liabilities but you will still be subject to failure to file penalties. But also keep in mind that the IRS expects the business to be an actual business and not a hobby business. You may need to prove that there was an attempt to operate the business as a business and not an enterprise to fund a personal hobby, not operated in order to incur a loss on purpose in order to create deductions. In this case, your wifes bi-polar condition may be a mitigating circumstance that might help in negotiating a payment plan.
Once you have done that, having organized everything to the best of your ability, unless you are comfortable completing and filing those returns, find a CPA to complete and file your returns. Yes it will cost you money but it will cost you more if you just take a shopping bag full of papers and let him or her sort it all out for you. If you belong to a professional org, a civic org, a church, or a local small business org. etc. consider looking there for a CPA who might be willing to give you a break on their fees. IMO, you dont need a tax attorney at this point; that is overkill and IMO not necessary unless youve been charged with criminal tax evasion, you just need help getting those taxes filed. That is the first step. Get those returns completed properly and completely and get them filed as soon as possible even if you cant pay any taxes and penalties owed at this time.
Once you file the back returns, if you are not able to pay the taxes and penalties and interest owed in full when you file, the IRS and the state will notify you for failure to pay. It is at this point that you will need to negotiate a payment plan or an offer in compromise. If you are not comfortable doing that yourself and want the CPA to do it for you, you will need to sign a limited power of attorney, else the IRS and state taxing agencies will not speak with him or her on your behalf. But word to the wise, you dont want to hire just any CPA, you dont want to hire an inexperienced or part time guy who prepares tax returns as a hobby. Even if you hire a CPA, you will still have to sign the returns you are still responsible for the accuracy of the return so make sure you understand what the CPA is doing and filing on your behalf. And stay away from those firms that advertize on radio and TV that promise to help you with your back taxes. What they are in effect are loan companies, they will pay your taxes but then will charge you exorbitant interest fees, much more than what the IRS will charge. Also be aware that paying your taxes via a credit card, assuming that you have enough of a credit line may also end up costing you more in interest.
I got into a bad situation a few years back. In the last quarter of 2008 and ending the first quarter of 2009 I had taken a position with a company where my former boss was working but I was hired as a 1099 consultant. At the time I was making very good money and had put aside money for the taxes, planned on filing and paying estimated quarterly taxes. But then the contract was suddenly terminated and I had zero income coming in, and being a 1099 contractor, was not eligible for unemployment. Over the course of the next year while looking for a job but not finding anyone to hire me, I used all that I had saved up to make my mortgage and utility payments, car payment and insurance and basic groceries (mostly mac and cheese and ramen noodles). But I made the mistake of not filing my 2008 and 2009 tax returns until late in 2010 because I knew I didnt have the money to pay the self employment taxes and when I did finally file, I didnt have the money to pay the taxes in full. I was also going through a deep depression exasperated by being hounded daily by creditors and jeopardy of having my house foreclosed on.
Once I did file in late 2010, I got a notice from the IRS threatening to levy my wages as I was by that time back to work. I took my tax return and proof of my current income at the time, which wasnt near as much as I had been making, my current expenses like rent, proof of my bankruptcy which I had just recently filed, and I went to the local IRS office in person. I was BTW able to pay the state the taxes and penalties due when I filed so I avoided that hassle.
Much to my surprise the IRS agent who worked with me was very nice and very understanding. She worked with me to come up with a payment plan that I could afford; $130 per month. And I continue making those payments faithfully and on time every month and often now pay more than the minimum due. Even with interest still accumulating I am at the point where I have reduced the original balance of $6k to less than $1k and plan to have that paid off in full by the Fall. I am looking into negotiating paying off the principal balance early and asking the IRS to wave the remaining penalties since Ive had such a good repayment record.
Good luck with it and keep us updated with your progress.