The United States Supreme Court decided on March 28, 1989, that if a state gives retired local and state government employees income tax exemption, then federal and military retirees living in the state should be extended them as well. North Carolina reacted by taking back exemptions it had been giving retirees. Bailey v. State of North Carolina arose because of that action.
Bailey v. State of North Carolina was a class-action lawsuit decided in the state's Supreme Court in 1998. James Bailey and his co-plaintiffs sued the state, the Department of Revenue, the State Treasurer and their respective retirement plans over income taxes collected on certain retirement benefits between 1989 and 1991. The plaintiffs believed that people who were vested former government employees — people who worked for state and local government for at least five years by August 1989 — should not have had their retirement benefits taxed upon withdrawal.
Retirees who worked in certain local, county and state government positions were included in the suit. Types of benefit collectors, to name a few, included public school teachers, University of North Carolina system employees, judges, people receiving short-term and long-term disability benefits through the state, law enforcement officers, firemen and National Guard members. Those individuals paid into benefit plans, such as the state's 401(k) and 457, during their years of employment that were payable upon retirement. Also, some former federal employees who worked in North Carolina, such as Coast Guard members, were impacted by the taxation.
The state settled the case on June 11, 1998, requiring $799 million be returned to impacted former employees effective July 1, 1998. The state Supreme Court found that the collection of the taxes was unconstitutional. The General Assembly collected funds from the defendants and created a reserve fund to refund the money to Bailey and the other plaintiffs. The Bailey decision provides that retirees with five years of service as of August 12, 1989, not be assessed state income tax on money received from certain retirement plans.
Retirees must claim a special deduction on line 47 of form D-400 when filing North Carolina income taxes. They must also provide proof — a 1099-R or W-2 — that the funds were from a plan that should not be assessed tax. Retired teachers and employees vested in other states but living in North Carolina are not eligible for the tax exclusion.
- "State Employees Association of North Carolina"; The Bailey Case; Eugene Boyce
- FindLaw: Bailey V. State
- State of North Carolina: Individual Income Tax, Estate Tax, Gift Tax: Rules and Bulletins Taxable Years 2005 and 2006
- North Carolina Department of Revenue: Bailey Decision Concerning Federal, State and Local Retirement Benefits