Michael and Kay were locked into self-deception. Michael constantly believed that he could be "legitimate," but continually rationalized his criminal behavior by believing himself to be no more crooked than supposedly legitimate types like politicians and judges. Kay, for her part, believed that she could "change" Michael's most fundamental behavior and values. She, too, rationalized Michael's failure to become "legit."
But, after the Tahoe shooting, Kay finally came to the conclusion that it was hopeless. Check out the look she gives Michael right after the shooting, when she'd clutching Anthony. She finally realized that she'd been misled--and had been misleading herself. That's why, in III, she gave Michael that sharp-edged speech about his hypocrisy in buying respectability from the Church, "common Mafia hood," etc.
My favorite distillation of their post-Tahoe relationship: Michael shouts at her, "I spent my life protecting my family from the horrors of this world." "But you became my horror," Kay replies. Right, Kay!