Tax Benefits

Bailey Decision Concerning Federal, State and Local Retirement Benefits

As a result of the North Carolina Supreme Court's decision in Bailey v. State of North Carolina, North Carolina may not tax certain retirement benefits received by retirees of the State of North Carolina and its local government or by the United States government retirees (including military) for each retirement plan if the retiree has five or more years of creditable service as of August 12, 1989. The exclusion also applies to retirement benefits received from the State's 401 (k) and 457 plans if the retiree had contributed or contracted to contribute to the plan prior to August 12, 1989. The exclusion does not apply to local government 457 plans, 403(b) annuity plans, or to retirement benefits paid to former teachers and state employees of other states and their political subdivisions. You can view the list of qualifying retirement plans in the North Carolina Department of Revenue Individual Income Tax Bulletins. A retiree entitled to exclude retirement benefits in arriving at North Carolina taxable income should claim a deduction on line 42 of the D-400 for the amount of excludable retirement benefits included in federal taxable income. A copy of Form 1099-R or W-2 received from the payer must be attached to the return to support the deduction.

Note: The "special separation allowance" paid to retired law enforcement officers pursuant to G.S. 143-166.41 and reported on Form W-2 does not qualify for exclusion under Bailey. However, the special separation allowance is subject to the $4,000 retirement benefits deduction.

Distributions from most types of retirement plans may be rolled over into another retirement plan or into an IRA. Because rollover distributions lose their character upon rollover, all distributions from a qualifying Bailey retirement account in which the employee / retiree was "vested" as of August 12, 1989, are exempt from State income tax regardless of the source of the funds contained in the account. Conversely, qualifying tax-exempt Bailey benefits rolled over into another retirement plan lose their character and would not be exempt upon distribution from the other plan unless the plan is a qualifying Bailey retirement account in which the employee was vested as of August 12, 1989. (Rollovers to IRAs will always result in a loss of tax-exempt status since IRAs do not qualify under the Bailey settlement.)