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News and Views about Taxes

What is the “Bailey Exclusion”?

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In 1989, the US Supreme Court decided in Davis v. Michigan Department of Treasury (489 U.S. 803) that Federal retirees could not be taxed differently than were State retirees. At the time, North Carolina exempted state retirees from being taxed on their retirement benefits, but taxed all other retirement benefits including those of Federal and military retirees. In order to comply with Davis, on August 12, 1989, the NC legislature passed Session Law 729 repealing the state employees’ exception – which had been written into the state’s contracts with its employee unions. In 1998, the NC Supreme Court ruled in Bailey v. State of North Carolina (348 N.C. 130) that the state could not tax the retirement benefits of NC state or local government employees who were vested in the retirement plan as of August 12, 1989 – and by the Davis decision, could not tax the retirement benefits of Federal government or military retirees who met the same requirements as the state retirees.

As a result of Bailey and Davis, any Federal, military, or NC state or local government retiree, or beneficiary of such a retiree, who is receiving retirement benefits from the corresponding government plan, and who had at least five years of credited service as of August 12, 1989, is exempt from North Carolina state tax on those retirement benefits. The “Bailey exclusion” also applies to retirement benefits received from NC state 401(k) or 457 plans if the retiree had contributed to the plan, or contracted to contribute to the plan, prior to August 12, 1989. The exclusion does not apply to local government 457 plans, nor does it apply to 403(b) annuity plans, nor does it apply to privately contracted retirement plans such as IRAs.

If you are entitled to the Bailey exclusion, you should report the entire amount of the exclusion on line 46 of your NC D-400, and attach a copy of your Form 1099-R to your return to support the claim of exclusion. You do not qualify for the $4000 exclusion on line 47.

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Written by nctaxpro

February 15, 2010 at 10:39 am

Posted in North Carolina, Taxes

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