Some current and former state employees may lose a valuable, little-known perk: the ability to roll private sector retirement savings into tax-exempt state accounts.
A legislative committee recently debated a draft bill that would close the loophole, which is estimated to cost the state $1 million a year.
“Whether you call it a loophole or a scam, it is what it is,” said Rep. Paul “Skip” Stam, the Republican speaker pro tem. “This draft they’ve got is the best bill you’ll pass this year.”
The bill would tax any private-sector retirement benefits as they’re paid out starting in 2016. Cindy Avrette of the General Assembly’s Research Division says the change could be costly to defend.
“This has been the policy of this state for over a decade,” Avrette said. “I feel certain that there could be litigation should the state choose to change that policy.”
That could make the bill more trouble than it’s worth, some legislators said. “I don’t think the revenue we’re going to receive is going to be enough to justify what we’re going to have to pay in lawsuits,” said Sen. Jerry Tillman, an Archdale Republican. “Is the juice worth the squeeze?”
Sen. Floyd McKissick, a Durham Democrat, said the change should apply only to employees who combine retirement accounts in the future – not workers who’ve been planning to retire on tax-free payouts.
“I would think there would be certainly some significant legal challenges that we would face if we tried to apply the law retroactively,” McKissick said.
North Carolina began taxing state retirement accounts in 1989 and almost immediately faced a lawsuit. In 1998, the N.C. Supreme Court ruled in favor of the plaintiffs that the state was contractually obligated to exempt employees who were vested in the state retirement account at the time of the law. This is known as the Bailey exemption, after one of the plaintiffs, Judge James H. Pou Bailey. Workers who became vested after 1989 pay income taxes on their retirement benefits.
State revenue officials have interpreted the ruling to mean that anything in a state retirement account vested by 1989 – including retirement savings from private sector work – should not be taxed at the time of withdrawal.
Under the proposed legislation, accounts vested before 1989 would remain exempt – but only for benefits earned working for the state.
“It seems to me this is an issue of pure fairness,” said Rep. Bill Brawley, a Matthews Republican. “We will no longer give them a benefit granted to them in error, but we will not go and take the money back.”
Legislators expect to receive legal opinions about the draft bill before discussing it again next month.