“you WILL be hit with failure to file penalties”
My experience is that the IRS does not asses the failure to file penalty that is on the books for individuals as long as there is a refund due the taxpayer. While the is a $100 penalty on the books if the return is over 60 days past the due date including extensions even when a refund is due, I have only seen them assess a penalty when there is a balance due.
In your situation, I strongly recommend that you total all the bank deposits and disbursements on your bank statements and reconcile these totals for the year to your income and expenses. This is what the IRS will do in an audit so you can head them off by protecting yourself with accuracy prior to filing the return. They will total all bank deposits and say that they are taxable income unless you can prove otherwise. (It’s called a cash proof and if you do a Google search there are templates to help you.)
When there is a balance due there are late filing and late paying penalties and if the amount due is a big one, they hit you with another 20% penalty. My experience is that even in IRS audits, if you had a good reason they will abate the penalties. If they don’t, don’t get mad or argue, just petition it to tax court where they really want to settle the case they are so over loaded.
The IRS is now so short staffed and overwhelmed with the amount of work they are doing as a result of all the legislative burden placed upon them with Obamacare that they are in chaos. The acting director stated at the AICPA Tax Conference in DC this past fall that “The IRS is in crisis mode.”
“the business is 50-50 owned by both”
Business should generally not be owned by both parties for liability protection. Same is true of autos. Real estate should be owned by both parties to protect it in case of bankruptcy or other liability. (Except in the case of divorce planning where it is often better to have it in a separate corp business name for ease in transferring deeds.)
LLC’s are easy to set up and do not create a separate tax entity if they are one owner. They don’t even get a separate tax ID # unless you are a partnership or have employees. They still give the liability protections. They are legal entities for liability protection but not for tax purposes. They are great. The only additional work depends upon your state’s corporation tax laws as sometimes they have capital stock and other returns that are required. See a tax professional in your state.
“The IRS is now so short staffed and overwhelmed with the amount of work “
My wife told me that same thing. They see the IRS about 3 times a month over delinquent accounts and they are stretched.
One thing they will need to check is how much “co-mingling” went on with the business and personal. That is really messy and pretty common.