NC State Retirement Taxes: Is Your TSERS Pension Taxable?

The tax treatment of your TSERS pension depends on federal tax rules and, for North Carolina income tax, whether you qualify for the Bailey settlement. Most retirees pay both federal and state income tax on their monthly benefit — but a group of long-tenured members pays no North Carolina state tax at all, thanks to a court settlement most newer members have never heard of.

Federal Income Tax

Your monthly TSERS pension is taxable as ordinary income at the federal level, less any tax-basis recovery under IRS Rule 72 (the Simplified Method). RSD calculates the taxable portion and reports it on your annual Form 1099-R.

You set your federal withholding preferences on Form 290, which you submit with your Form 6E before retirement. You can also adjust withholding at any time through ORBIT after you're retired.

North Carolina State Income Tax

TSERS benefits are generally subject to North Carolina state income tax. The exception is substantial: the Bailey v. State of North Carolina settlement.

Under the Bailey settlement, retirees who had five or more years of creditable service as of August 12, 1989 are exempt from North Carolina state income tax on their TSERS pension payments. This exemption is permanent — it applies for life, regardless of how much you receive.

You qualify if you had at least five years of TSERS creditable service by August 12, 1989. A hire date alone does not establish whether you met that service test, especially if you had a break in service. Members hired after August 12, 1989, do not meet the cutoff.

Check your service history and Form 290 state withholding against the Bailey exemption. A tax professional (CPA or Enrolled Agent) can confirm your eligibility and help adjust your withholding.

Form 1099-R and Annual Filing

RSD issues IRS Form 1099-R by January 31 each year. It reports:

• Gross distributions (total pension payments for the year)
• Taxable amount (gross minus any tax-basis recovery)
• Federal and state income tax withheld

You'll file this with your federal and state returns. Bailey exempts qualifying pension payments from North Carolina income tax; federal taxation follows the taxable amount reported on Form 1099-R.

Tax Withholding Strategy

Most retirees set up withholding on Form 290 and adjust it once based on their first full-year 1099-R. A few things to consider:

• If you choose a joint-and-survivor option, your monthly check is lower than the Maximum Allowance, which means your taxable income from TSERS is lower. Set withholding based on the actual check amount, not the Maximum Allowance figure.
• If you have other retirement income (NC 401(k), NC 457 distributions, Social Security), your total taxable income may push you into a higher bracket. A tax professional can model the combined picture.
• North Carolina has a flat state income tax rate, so the bracket question is federal only.

The WEP/GPO Confusion

The Social Security Fairness Act (signed January 5, 2025) repealed the Windfall Elimination Provision and Government Pension Offset retroactively to January 2024. This doesn't change the taxation of your TSERS pension. It means that if your Social Security benefit was previously reduced because of a non-covered government pension, that reduction is gone — and your Social Security income may now be higher, which affects your total taxable picture.

TSERS members contribute to Social Security (FICA) alongside their 6% TSERS contribution, so WEP and GPO rarely applied to TSERS members directly. But spousal and survivor Social Security benefits were sometimes affected. If that's your situation, the higher Social Security check means more taxable income — worth discussing with a tax professional.

Getting the Tax Picture Right

The NC TSERS Retirement Guide covers the Bailey exemption, the Form 290 withholding setup, and how to coordinate TSERS taxation with Social Security and supplemental retirement accounts — so you set withholding accurately from the first check instead of discovering an underpayment at filing time.

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