Heather Henstock

If the current state of bakery ingredient prices isn't enough to tax a retail baker's sanity, try grappling with legislators over the definition of a prepared food. For Missy and Lionel Vatinet of La Farm Bakery in Cary, N.C., much more than their sanity was at stake. Their bakery business and their livelihood were in jeopardy when North Carolina Department of Revenue slapped the bakery with a $150,000 bill for back taxes.

The bakery had been charging 2 percent sales tax for its bakery products, which was the correct “grocery store” tax at the time they opened their bakery in 1999. Not until they were first audited in 2005 did the state notify them that bakery products are classified as “prepared foods,” which require a 7.75 percent sales tax. Under the state's definition, a prepared food is food that is sold hot or heated by the retailer, mixed or combined by the retailer, or sold with eating utensils provided by the retailer.

Is a loaf of bread a combined food item? Can flour, yeast and salt stand on their own as food? Obviously not. But, tax laws often still qualify bakery products as prepared foods if they are sold in the retail bakery where they are produced. If, however, that retail bakery sells its same bread to a grocery store, the grocery store only has to charge 2 percent. This loophole ultimately makes it more expensive for customers to shop the retail bakery.

Minnesota dealt with a similar issue in 2002 with its “bread tax” that was eventually repealed. North Carolina bakers are breathing some sighs of relief from the initial crisis over their confusion from poor communication by state officials. Earlier this month, the state passed legislation that exempts bakers from back tax bills for not charging the full sales tax. But, that doesn't resolve the ambiguous prepared foods definition of a bakery product that could affect retail bakeries nationwide.

In addition, once a bakery begins adding coffee, sandwiches, seating and other bakery café-like amenities, which one or two bakers are doing these days, the definition gets even more confusing. Minnesota and North Carolina are among the many states participating in the Streamlined Sales Tax Project, which is a valid effort to streamline tax codes among states. Although unintentional by state legislators, the retail baker is getting caught in the crossfire.

Large corporations can afford lawyers and CPA teams to decipher tax laws, and they can support national associations to back their causes on Capitol Hill. Small businesses too often can't afford to defend themselves and are hit the hardest when legislation, such as tax codes, go awry. Margins are already slim for retail bakers who are being squeezed even further under the current economy.

Are you or other retail bakeries you know of struggling with the prepared foods sales tax code? Maybe it is not a big issue, or maybe it hasn't hit your state yet? Either way, we'd like to hear from you if you have any thoughts on how to deal with it. La Farm's Missy Vatinet, Jerry Ray of Mickey's Pastry Shop and others have spent years working through North Carolina legislators on behalf of retail bakers in their state, but moving to the national level is a whole new ball game.