The Bailey/Emory/Patton decision refers to three lawsuits – Bailey et al. v. State of North Carolina et al.; Emory et al. v. State of North Carolina et al.; and Patton et al. v. State of North Carolina et al. – that successfully challenged the state’s collection of income tax on retirement benefits for certain government employees.
Prior to 1989, benefits received by state and local government retirees were exempt from state and local taxes; by contrast, only a portion of federal retiree benefits were exempt from taxation. In 1989, the U.S. Supreme Court ruled in Davis v. Michigan that it was unconstitutional to tax federal retirement benefits differently from state or local benefits. In response, the General Assembly imposed a tax on all government retirement benefits, excluding the first $4,000 (S.L. 1989-792). In 1990, state and local government retirees filed a class action lawsuit representing some 200,000 plaintiffs. Subsequently, state retirees filed a similar lawsuit based on slightly different grounds (Emory) while federal retirees also brought suit (Patton).
After several years of litigation and five appearances before the state Supreme Court, Bailey was finally settled in 1998. In 1991, the N.C. Supreme Court initially ruled against the plaintiffs over matters related to compliance with income tax protest requirements as delineated in N.C.G.S. 105-267. In October 1992, the plaintiffs filed suit again. In September 1995 the Wake County Superior Court ruled in their favor and ordered an income tax refund for those state and local retirees who had filed a timely protest (cf. N.C.G.S. 105-267).The state, represented by then-Attorney General Michael Easley, appealed the decision. Federal retirees also filed suit (Patton), claiming that Bailey had not resolved the inequities that existed between state/local retirees and federal retirees because the state had increased the retirement benefits for state retirees at the same time that it had imposed a tax on those benefits, thus reinstating the tax inequalities that existed before Davis v. Michigan.
Taking up the three cases in 1998, the N.C. Supreme Court found that the tax on retiree benefits constituted “an unconstitutional impairment of contract and a taking of property without just compensation.” As in Smith v. State, the court also ruled that refunds could not be limited only to those who had filed a timely protest. Emory and Patton were likewise settled by the court’s ruling, with little comment on the specifics of either case.
In May 1998, the N.C. Supreme Court sent Bailey/Emory/Patton back to the trial court with orders regarding who would qualify for a refund. But the state settled the cases before the trial court could issue a final ruling. Per legislation passed by the General Assembly that June, the state consented to pay $799 million over two years – FY 1998-99 and FY 1999-2000 – to refund taxes on state, local and federal retiree benefits paid by all vested federal, state, and local government retirees between 1989 and 1997. As a result of the repeal of the unconstitutional tax, the state forfeited approximately $130 million dollars in annual revenue.