I need some opinions here. I started decorating cakes as a hobby about 2 years ago. I'm not an artist (or even cake decorator for that matter) by trade. I don't really do the typical sheet cakes. I enjoy molding and shaping and making cakes unlike what anyone else in this area does. I live in NM, a state that does not allow you to run a business out of your kitchen, and I decorate cakes.
Because of this I have never done any kind of advertising or charging. I get cake request by word of mouth & take donations as a type of payment.
The problem with this is that I think I am barely breaking even on my cost and not making anything for my time. I spend hours on the cakes I make and end up with just enough cash to buy the supplies for the next cake request.
So what can I do? Can I request a starting price "donation"? or a flat price per serving? And by doing this am I going to have any problems with the health inspectors?

If you get caught then yes... you will have problems with your health department. Most likely a warning for the first infraction and then fines after that, but sometimes you get fined from the get go, and if you get warned you will be on their radar with extra "loving" attention. I guess you have to decide what is worth it to you. Would it be worth it to me? Hellz no. It would suck to make a cake and get paid some piddly amount and then get stuck with a $1000 fine for said piddly paycheck. Can you find a kitchen to rent? That would be the best way to go about it. Some churches have commercial kicthens and will allow you to rent time. There is always a way to to something right if you really want to do it. If not then it might be a good idea to just do cakes as gifts on occasion and do them for family.

Plain and simple, what you are doing isn't legal... even just getting money for supplies isn't legal. It sucks, but that's the way it is. I'd hate to see you get in trouble for it... especially if you aren't making good money to begin with.

Humm....I will have to check with some of the churches. That really sucks cause I have a 10 month old baby & usually do all my work once she has gone to bed. There's no way I'm gonna put her in daycare just so I can make a cake. Especially since I don't make much money at it. oh well.

I know it sucks... and I feel deeply for people who aren't allowed to work from their residential kitchen. You may be able to get a good deal on renting a kitchen. Maybe you could even barter for time. Do a cake a few times a year for them in exchange for time in the kitchen. If you are doing this for family and close friends I really don't see an issue with you just doing it from home. Your family isn't going to turn you in right? But if you are going to start branching out into the general public then it's worth it to seek out ways to do this the right way so you don't end up paying in the end. The hard truth is that doing this for friends and family isn't going to make you tons of money, and you can't advertise if you are trying to fly under the radar.

Talk to churches (but they must have a licensed kitchen... all church kitchen aren't licensed), talk to caterers, talk to breakfast/lunch places who will have free kitchens at night. Are you allowed to have a separate non-commercial grade kitchen in your home to make cakes? If so then look on craigslist or eBay for some used equipment... if it doesn't have to be a commercial grade kitchen, you can put together a second kitchen pretty cheap. Talk to your health department... see what the requirements are and go from there.

This may not help you in the short term, but there is a group called Farm to Table in New Mexico that is trying to pass a cottage foods law there.

http://www.farmtotablenm.org/

I'm a hobby baker that bakes out of her home and charges. I don't have any desire to do cakes full time so I am not going to go to the expense to get a legal kitchen to do 10-12 cakes a year. I also only bake for family and friends.

I hate to say it, but I think that if you are getting paid donations you are still getting paid. So if you are going to go the route of getting something in return for your time and supplies you are better off just charging people, rather than taking donations.

Talk to your health department and see what the rules and regulations are for your state and county. I know there are some places that will allow it if you stay under a certain number of cakes or someting.