Purchase of Omitted Service-Eligibility to Receive Retirement Benefits Tax

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