North Carolina Military Retirement Pay Deduction

North Carolina taxed military retired pay in full for most retirees until recently. Legislation effective for taxable years beginning on or after January 1, 2022 created a deduction that removes it from North Carolina taxable income. The deduction is available to a taxpayer who meets either of two tests. The first is having served at least 20 years in the uniformed services. The second is having been medically retired under 10 U.S.C. Chapter 61. The Department of Revenue is explicit that severance pay under that same chapter does not qualify, which is a distinction a medically separated service member has to watch: retirement qualifies, severance does not. The deduction reaches survivors too. Payments under a plan defined in 10 U.S.C. section 1447, which is the Survivor Benefit Plan, to a beneficiary of a retired member who was eligible to deduct retirement pay are also deductible. There is one structural limit. The deduction is only allowed to the extent the payments are included in the taxpayer's adjusted gross income. Income that never entered federal AGI cannot be deducted again at the state level. A retiree with fewer than 20 years who was not medically retired does not qualify, and North Carolina taxes that retired pay. That is the group most likely to be surprised, because the benefit is often described as though it covered all military retirees. A separate and older exemption, the Bailey exemption, covers retirees with five or more years of creditable service as of August 12, 1989 and is broader where it applies. That has its own entry here, and a retiree who qualifies under Bailey should use it rather than this deduction. Combat zone pay excluded from federal taxable income is also excluded from North Carolina taxable income, with the same 180-day filing extension. North Carolina forgives state tax owed by a resident service member killed in a combat zone, or who died of wounds, disease, or injury received in one.