Toffee was born before the Mushroom War as a human named Olivia Rivers. Prior to the war, Oliva had a pretty average life: she had loving middle class parents, went to college for accounting, and was recently working at an accounting firm when the war began. And it was then that her life was going to change.
Olivia was on her way to work when was bomb that ended the world went off in her city. She was one of the many caught in the initial blast. Broken and on the brink of death, Oliva was saved due to candy elemental magic. And while it saved her...it also made her insane. Oliva wander the wastelands for quite some time until she sealed herself in a hard chocolate shell and was dormant for two hundred years.
After those initial 200 years, the infant Candy Kingdom began to build itself close to her resting place. It was then when Oliva left her chocolate shell as Toffee the Candy Witch. Still very insane, she frightened the Candy People but was mostly harmless to them. Seeing how this strange woman was scaring her subjects and seeing how Toffee was harmless for the most part, Princess Bubblegum simply had Toffee isolated to the farthest corner of the Cotton Candy Forest where she would go on to build her candy cottage.
While she had become saner over time, her period of time while insane has made the newly built Candy Kingdom wary of her, making her an outsider.