Genetic background effects contribute to the phenotypic consequences of mutations and are pervasive across all domains of life that have been examined, yet little is known about how they modify genetic systems. In part this is due to the lack of tractable model systems that have been explicitly developed to study the genetic and evolutionary consequences of background effects. In this study we demonstrate that phenotypic expressivity of the scalloped(E3) (sd(E3)) mutation of Drosophila melanogaster is background dependent and is the result of at least one major modifier segregating between two standard lab wild-type strains. We provide evidence that at least one of the modifiers is linked to the vestigial region and demonstrate that the background effects modify the spatial distribution of known sd target genes in a genotype-dependent manner. In addition, microarrays were used to examine the consequences of genetic background effects on the global transcriptome. Expression differences between wild-type strains were found to be as large as or larger than the effects of mutations with substantial phenotypic effects, and expression differences between wild type and mutant varied significantly between genetic backgrounds. Significantly, we demonstrate that the epistatic interaction between sd(E3) and an optomotor blind mutation is background dependent. The results are discussed within the context of developing a complex but more realistic view of the consequences of genetic background effects with respect to mutational analysis and studies of epistasis and cryptic genetic variation segregating in natural populations.