Bailey Decision Concerning Federal, State and Local Retirement Benefits
Unless otherwise noted, the following information applies to individuals for tax year 2022. For information about another tax year, please review the Department’s Instructions and Bulletins for that year.
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 (or by beneficiaries of retirees) of the State of North Carolina and its local governments or by the United States government retirees (including military). The exclusion applies to retirement benefits received from certain defined benefit plans, such as the North Carolina Teachers' and State Employees' Retirement System, the North Carolina Local Governmental Employees' Retirement System, the North Carolina Consolidated Judicial Retirement System, the Federal Employees' Retirement System, or the United States Civil Service Retirement System, if the retiree had 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 retirement benefits paid to former teachers and state employees of other states and their political subdivisions.
A retiree entitled to exclude retirement benefits from North Carolina income tax should claim a deduction on Line 20, Form D-400, Schedule S 2022 Supplemental Schedule, for the amount of excludable retirement benefits included in federal adjusted gross income. Even if all your retirement is excludable under Bailey, you must still file a North Carolina return if you meet the minimum gross income filing requirements. A copy of Form 1099-R or Form W-2 received from the payer must be attached to the return to support the deduction.
For additional information, see the Personal Taxes Division Bulletins.
Rollover Distributions with Respect to Bailey Retirement Plans - General
The Economic Growth and Tax Relief Reconciliation Act of 2001 made numerous changes with respect to pension portability. 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 distributions from the other plan unless that plan is a qualifying Bailey retirement account in which the employee was vested as of August 12, 1989.
For more information, see Departmental Directive PD-04-1. For special rules regarding the Optional Retirement Program, see Departmental Directive PD-00-1.
Bailey Retirement Plan Rollover Distribution to a Roth Account
Effective January 1, 2008, distributions from qualified retirement plans could be rolled over into Roth IRA's. Qualified retirement plans include 401(k), 403(b), and 457 plans. A rollover distribution to a Roth account is generally taxable at the time of the rollover and the subsequent distributions from the Roth account are generally not taxable. If the rollover to a Roth account is from a qualifying tax-exempt Bailey retirement account, the rollover distribution is exempt from State income tax and deductible on the State return to the extent the rollover distribution was included as income on the taxpayer's federal income tax return. For more information, see Department Directive PD-14-1.