How do you define prepared food? Wacky Tax Wednesday

On February 13, 2024, a new sales and use tax law took effect in Michigan that amends the definition of “prepared food.” Public Acts 141 and 142 help ensure Michigan remains compliant with the Streamlined Sales and Use Tax Agreement, which strives to simplify sales and use tax administration for businesses.

The thing is, there’s nothing simple about how Michigan taxes prepared food. Taxability hinges on how much prepared food a seller sells, and whether/how the seller provides utensils to customers.

Most food and food ingredients, otherwise known as groceries, are exempt from Michigan sales and use tax. “Prepared food” is not. 

Michigan law defines “prepared food” as:

• Food sold in a heated state or that is heated by the seller

• Two or more food ingredients mixed or combined by the seller for sale as a single item, or 

• Food sold with eating utensils provided by the seller, including knives, forks, spoons, glasses, cups, napkins, straws, or plates, but not including a container or packaging used to transport the food

The first two points are pretty straightforward. The last one? Not so much.

You might think the meaning of “eating utensils provided by the seller” is self-evident, but whether it is or isn’t doesn’t really matter. If the law doesn’t provide a crystal clear definition, there’s wiggle room: A tax department can say what a taxpayer sells is taxable; the taxpayer can say what they sell isn’t taxable; and round and round they’ll go.  

In an attempt to stave off confusion about the taxability of prepared food sales, the Michigan Department of Treasury created Rule 86(5)(b) in 2007. The rule requires sellers to calculate their percentage of prepared food sales to determine whether eating utensils are “provided by the seller”: 

• When a seller’s percentage of prepared foods sales is greater than 75% of their total sales, eating utensils are considered to be “provided by the seller” if they’re merely made available to purchasers

• When a seller’s percentage of prepared foods sales is 75% or less of their total sales, eating utensils are considered to be “provided by the seller” only if it’s the seller’s practice to physically give or hand the utensils to purchasers

I don’t know about you, but I find this confusing.

Rule 86(5)(b) was called in question after a business operating movie theaters in the state requested a refund of sales tax remitted on bottled water and prepackaged candy. The matter ended up in court, and in 2020, the State of Michigan Court of Appeals invalidated the 75% test.

The court’s decision pointed out that 1) Michigan statute doesn’t define or explain the phrase “provided by the seller,” and 2) the Michigan Department of Treasury “promulgated a rule that goes beyond the statutory language and establishes the 75% test whereby the definition of ‘provided by the seller’ changes depending on the taxpayer’s percentage of sales.”

“The statute clearly states that food sold with eating utensils provided by the seller would not be exempt — full stop,” observed the court. “It makes no attempt to distinguish between food that is above or below a particular sales percentage.”

The court was unpersuaded by Treasury’s argument that it’s authorized to administer the Streamlined Sales and Use Tax Agreement (SSUTA), and that the SSUTA allows for the 75% test. And the invalidation of Rule 86 put Michigan at risk of being out of compliance with the SSUTA. If a member state is found to be noncompliant, it can be sanctioned and must take steps to return to compliance.

Enter House Bills 4377 and 4378 (aka 2023 Public Acts 141 and 142). The bills add a definition of “food sold with eating utensils provided by the seller” to the statute, broaden the definition of “utensils,” and clarify how bottled water, candy, and soft drinks fit in.

PAs 141 and 142 leave the statute’s original three categories of “prepared food” unchanged. “Prepared food” is:

• Food sold in a heated state or that is heated by the seller

• Two or more food ingredients mixed or combined by the seller for sale as a single item, or 

• Food sold with eating utensils provided by the seller

What’s new under the acts is that, effective February 13, 2024, the meaning of “eating utensils provided by the seller” is expanded. 

Three of the new criteria added by PAs 141 and 142 for “provided by the seller” codify parts of Treasury’s now defunct Rule 86. Effective February 13, as under Rule 86, a utensil is “provided by the seller” when one of the following is true:

1. The seller or another person (not a manufacturer) puts a utensil in the product’s packaging

2. The seller’s business practice is to give or hand utensils to customers

3. The seller makes available utensils necessary for the purchaser to receive the food 

PAs 141 and 142 also add a fourth standard:

1. The seller makes available eating utensils

However, the fourth standard doesn’t apply to all food items or all sellers. It doesn’t affect the taxability of bottled water, bottled soft drinks, candy, and certain food items with multiple servings. It also doesn’t apply to sellers whose prepared food sales are 75% or less of their total sales.

Like the old Rule 86, PAs 141 and 142 create a “bifurcated scheme” that requires the seller to calculate their percentage of prepared food sales.

For sellers whose sales of prepared food are 75% or less of their total sales, the definition of “utensils provided by the seller” isn’t changed by PAs 141 and 142. The general standard — points one through three, above — holds true.

For sellers whose sales of prepared food exceed 75% of their total sales, PAs 141 and 142 expand the definition of “utensils provided by the seller” to include the fourth point (i.e., “the seller makes available eating utensils”).

So, on and after February 13, 2024, if your prepared food sales percentage exceeds 75%, you’re subject to the following new, special standard: A utensil is considered “provided by the seller” if you “make an eating utensil available.” This rule does not require the utensils to be “necessary for the purchaser to receive the food.” 

A side-by-side comparison may help make Michigan’s law clearer. (Fingers crossed.)

As explained above, when Rule 86 ended up in court, the Michigan Department of Treasury argued its 2007 percentage-based prepared food rule was valid because Treasury was authorized to administer the Streamlined Sales and Use Tax Agreement, and the agreement allowed for this test.

The SSUTA’s definition of prepared food “sold with eating utensils provided by the seller” does include the bifurcated scheme. The agreement has a definition for businesses whose prepared food sales percentage is greater than 75%, and another definition for businesses whose prepared food sales are 75% or less. (You can find the relevant sections on page 118 and 119 of the agreement.) Other member states, including Washington, use the 75% rule too.

The purpose of the Streamlined Sales and Use Tax Agreement is “to simplify and modernize sales and use tax administration in order to substantially reduce the burden of tax compliance,” and it does. Unfortunately, sales tax laws are so unwieldy that sometimes simplifying them makes them complicated. Or so it seems to me. 

The Michigan Department of Treasury has promised to issue a new Revenue Administrative Bulletin on this topic: Sales and Use Tax — Food for Human Consumption. It will replace RAB 2022-4. As of February 14, 2024, we’re still waiting. In the meantime, the department’s Change in Tax Treatment for Prepared Food has additional information.

Avalara is a Streamlined Sales Tax Certified Service Provider (CSP). For qualifying sellers, Streamlined Sales Tax states like Michigan will cover the cost of sales tax solutions provided by a CSP. Discover how Avalara can help your business simplify sales tax compliance in Michigan and other states.