If six Chapel Hill police officers should have been enrolled in their retirement system in mid-1984 but weren't enrolled until November 1984 by mistake, can they now buy that omitted service and retroactively qualify for the Bailey tax exemption on their retirement benefits?

Plain-English summary

Six Chapel Hill public safety officers started work on January 10, 1984. Under Town policy at the time, they had to wait six months before enrolling in either the Local Governmental Employees' Retirement System ("Local System") or the now-defunct Law Enforcement Officers' Retirement System. That six-month window closed July 10, 1984; they should have been enrolled then. By administrative oversight, they were not actually enrolled until November 1984, and nobody bought back the four-month gap in the sixteen years that followed.

By 2000, that oversight had become consequential. The reason was the North Carolina Supreme Court's 1998 decision in Bailey v. State. Bailey held that, under the Contract Clause, the state could not retroactively impose income tax on the retirement benefits of public employees who were vested in their retirement systems on August 12, 1989, the date the General Assembly enacted the legislation taxing those benefits. Vesting in the Local System normally required five years of creditable service. Bailey-class members get their North Carolina retirement income state-tax-free for life.

Chapel Hill's Town Attorney, Ralph Karpinos, asked the AG whether the six officers could now buy back the missing July-November 1984 service under G.S. § 128-26(m) and thereby qualify for Bailey treatment. The argument would be: but for the administrative error, they would have been credited with the 1984 months from the start, and they would have hit five years of service before August 12, 1989. If they buy that omitted service now, the argument runs, they retroactively achieve vesting and Bailey status.

AG Mike Easley's office said no. Bailey is fundamentally a snapshot statute: it asks who was actually vested on August 12, 1989, not who would have been vested in some alternative universe. The officers, on August 12, 1989, had less than five years of creditable service standing in the system. Therefore, on August 12, 1989, they did not yet have any contractual right to the pre-tax retirement provisions. Buying omitted service in 2000 added current creditable service to their accounts but did not (and could not) retroactively change what their service balance was eleven years earlier. The 1998 Bailey consent order made the same point: eligibility for the Bailey class was defined as having received retirement allowances by reason of "five years' creditable service . . . as of August 12, 1989."

The bottom line: the six officers could go ahead and purchase the omitted service if they wanted the extra credit toward their pension benefit, but their retirement benefits would not be exempt from state income tax under Bailey.

Currency note

This opinion was issued in 2000. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

The basic structure of the Bailey exemption has remained: it still keys off vested status as of August 12, 1989, and it remains administered as a settlement class with eligibility rules tied to the 1998 Bailey consent order. Tax treatment, retirement-system mechanics, and the specific statute on purchasing omitted service have been amended periodically since 2000, and individual eligibility questions are routinely litigated. Anyone trying to use this opinion to analyze a present-day fact pattern should pull the current Department of Revenue guidance and the present version of the Bailey class definition rather than rely on the 2000 framing.

Common questions readers actually have

What is the Bailey exemption, in one sentence?

A North Carolina public retiree whose pension was vested in a covered retirement system (Local System, Teachers' and State Employees' Retirement System, judicial retirement, federal civil service, military retirement counted at certain dates) by August 12, 1989, can exclude that retirement income from North Carolina income tax.

Why does the August 12, 1989 date matter?

That is the date the General Assembly enacted the legislation removing the longstanding state income tax exemption for state and local government retirement benefits. The Bailey court held that, for employees whose benefits had already vested under the prior rules, that change broke a contract. So it grandfathered them. Anyone vested before that date stays in the exemption; anyone who vested later or has not vested yet pays state income tax on their retirement income like anyone else.

Could the omitted-service purchase have helped if the officers had bought it in 1988?

Yes. The opinion explicitly notes: "If they had purchased the omitted membership service prior to August 12, 1989, then they would have had the creditable service in time to be vested before the General Assembly enacted legislation including state and local government retirement benefits in taxable income for state income taxes." The problem was timing, not principle.

Does the opinion change the value of buying the service for other purposes?

No. The opinion does not say "don't buy the service." Adding creditable service can still boost an officer's eventual monthly retirement check and can affect when the officer becomes retirement-eligible. It just doesn't change Bailey treatment. Whether the dollars-and-cents tradeoff makes sense is a separate analysis for each officer.

Was this an unusual fact pattern or did this come up a lot?

Bailey produced a steady stream of follow-on questions for years. Every public employee who was close to the five-year line in August 1989 had a story about how they got there: leaves of absence, breaks in service, military leave, transfers between systems, administrative errors like the Chapel Hill officers'. The retirement-system staff and the AG's office spent significant time on the back-and-forth. This Chapel Hill opinion is one of many; the answer was consistent each time: status as of August 12, 1989 controls.

Background and statutory framework

Bailey v. State, 348 N.C. 130 (1998)

In Bailey, the Supreme Court of North Carolina held that the relationship between the state and members of its retirement systems is contractual, that contractual rights vest when an employee accumulates enough creditable service (usually five years), and that the General Assembly cannot constitutionally impair vested benefits by imposing a new income tax on them. Quoting Simpson v. Local Governmental Employees' Retirement System, 88 N.C. App. 218, 223-24, the court wrote that members "had a contractual right to rely on the terms of the retirement plan as these terms existed at the moment their retirement rights became vested." 348 N.C. at 141. The court therefore struck down, as applied to vested employees, legislation that subjected retirement benefits to state income tax beginning in 1989.

The 1998 consent order

To implement Bailey, the parties filed a Consent Order in Wake County Superior Court on June 11, 1998. Paragraph 6 stipulated that eligibility, for state and local government retirees, was based on "receiving retirement allowances by reason of five years' creditable service in a . . . North Carolina state or local government retirement system as of August 12, 1989." That settled the timing question: vested status had to exist at that date.

G.S. § 128-26(m): the omitted-service purchase statute

Section 128-26(m) of the Local System statute lets a member purchase creditable service for periods when the member was employed by a participating employer but, by oversight, not enrolled. The credit purchased is real and counts toward future retirement eligibility and benefit level. It does not, however, function as a time-travel device: as the AG explained, the purchase changes the member's credit going forward, not the historical record of what the member had on a given past date.

The signing officials

The opinion was signed by Grayson G. Kelley, Senior Deputy Attorney General, and Norma S. Harrell, Special Deputy Attorney General.

Source

• Landing page: https://ncdoj.gov/opinions/purchase-of-omitted-service-eligibility-to-receive-retirement-benefits-tax/

Original opinion text

Re: Advisory opinion: Effect Of Purchase Of Omitted Service On Eligibility To Receive Retirement Benefits Tax-Free under Bailey v. State, 348 N.C. 130, 500 S.E.2d 54 (1998).

Dear Mr. Karpinos:

You have requested our opinion concerning the effect that purchase of omitted membership service with the Local Governmental Employees' Retirement System ("Local System") for the period from July 10, 1984, to November of 1984 would have on the eligibility of certain Chapel Hill public safety officers to receive their retirement benefits in the future exempt from state income taxation pursuant to the decision in Bailey v. State, 348 N.C. 130, 500 S.E.2d 54 (1998).

Your question concerns six public safety officers who began employment with the Town of Chapel Hill on January 10, 1984. At that time, the Town participated in the Local System, N.C.G.S. §§ 128-21 et seq., and the officers had the option of joining either the Local System or the former Law Enforcement Officers' Retirement System ("LEO") under former N.C.G.S. § 143-166. However, the Town imposed a six-month waiting period on new employees before enrolling them in either the Local System or LEO. Apparently by oversight, these six officers were not in fact enrolled in LEO or the Local System until November of 1984 although they were eligible to be enrolled as of July 10, 1984, upon completion of their first six months of employment. Nor has credit been purchased in the Local System for the omitted service in the sixteen years since then. See N.C.G.S. § 128-26(m). (All the officers are now members of the Local System, LEO having been dissolved and local government law enforcement officers transferred to the Local System pursuant to N.C.G.S. § 143-166.50.)

You ask whether, if the officers now purchased credit for the period between July 10, 1984, and their enrollment in November of 1984, pursuant to N.C.G.S. § 128-26(m), they would be entitled under the Bailey decision to receive benefits exempt from state income taxes when they eventually retired. Bailey held that taxation of state and local government retirement benefits, imposed beginning in 1989, could not be constitutionally applied to members of most of the retirement systems for state and local government employees if they were "vested" in their respective retirement systems at the time the legislation was enacted, on August 12, 1989. In Bailey, the Supreme Court of North Carolina built on prior decisions to hold that the relationship between the State and members of the retirement systems are contractual and that contractual rights in the terms of the retirement statutes arise upon attaining the necessary service to "vest" in the applicable retirement system, normally at five years. Quoting from Simpson v. Local Governmental Employees' Retirement System, 88 N.C. App. 218, 363 S.E.2d 90 (1987), aff'd per curiam, 323 N.C. 362, 372 S.E.2d 559 (1988), the Court declared:

Plaintiffs, as members of the North Carolina Local Governmental Employees' Retirement System, had a contractual right to rely on the terms of the retirement plan as these terms existed at the moment their retirement rights became vested.

Id. [88 N.C. App.] at 223-24, 363 S.E.2d at 94 (quoting Great Am. Ins. Co. v. Johnson, 257 N.C. 367, 370, 126 S.E.2d 92, 94 (1962)) (emphasis added).

Bailey, 348 N.C. at 141, 500 S.E.2d at 60. Consequently, legislation subjecting retirement benefits to state income taxes for the first time was unconstitutional "with regard to employees whose benefits had vested when it was passed." Id. at 153, 500 S.E.2d at 67.

The thrust of the Bailey decision is that employees who were vested in their retirement systems at the time the taxing legislation was enacted had a right at that time to the benefits of the retirement provisions that existed when they vested. Those persons who are Bailey class members were entitled, on August 12, 1989, not to have adverse changes enacted regarding their retirement systems because they had the necessary creditable service at that time to be vested. The same cannot be said of the six public safety officers who now wish to purchase credit for the omitted membership service between July 10, 1984, when they completed their waiting period, and November of that year. When the General Assembly enacted the statutes taxing Local System retirement benefits, the six public safety officers did not have five years' service standing to their credit; they were not then vested in the Local System. If they now purchase the omitted membership service, they will acquire additional credit based on their service during the period from July 10, 1984, to November, 1984. However, while that purchase would give them credit now for the additional months in 1984, it does not change the fact that, as of August 12, 1989, they had less than five years' service standing to their credit and therefore were not vested. Purchasing the service credit in 2000 does not retroactively vest them as of 1989, but instead gives them current credit for the purchased time. Regardless of whether they purchase the omitted membership service, they did not have five years' service standing to their credit as of August 12, 1989, and therefore they did not have a right as of that date to the benefit provisions of the retirement statute. Consequently, when the General Assembly imposed the state income tax on Local System and LEO retirement benefits by legislation enacted August 12, 1989, the six public safety officers were not vested in their retirement systems and had no right under Bailey to receive their retirement benefits tax-free.

You also asked how the Consent Order filed in Wake County Superior Court in the Bailey litigation on June 11, 1998, affected this inquiry. In Paragraph 6 of that agreement, the parties stipulated that eligibility for participation in the Bailey litigation, insofar as state and local government retirees were concerned, was based on "receiving retirement allowances by reason of five years' creditable service in a . . . North Carolina state or local government retirement system as of August 12, 1989." As of August 12, 1989, the six public safety officers did not have five years' membership service and therefore they are not eligible for Bailey benefits. If they had purchased the omitted membership service prior to August 12, 1989, then they would have had the creditable service in time to be vested before the General Assembly enacted legislation including state and local government retirement benefits in taxable income for state income taxes. Because they did not make the purchase in time to have five years on August 12, 1989, the officers were not "vested" as of that date and are not entitled to receive their retirement benefits free of state income taxes even if they eventually purchase the omitted service.

In sum, the six public safety officers who were not enrolled in their respective retirement systems until November of 1984 were not vested in their retirement systems as of August 12, and will not be entitled to receive their retirement benefits free from state income taxes even if they purchase credit for the time from July 10, 1984, until November of that year.

Signed by:

Grayson G. Kelley
Senior Deputy Attorney General

Norma S. Harrell
Special Deputy Attorney General