Does North Carolina Tax Military Retirement?

North Carolina provides a tax deduction for military retirement income, allowing eligible individuals to exclude this pay from their state taxable income. This benefit applies to military retirees and their surviving spouses. This article covers what income qualifies and how to claim it.

North Carolina’s Tax Exemption for Military Retirement

North Carolina provides a full state income tax deduction for eligible military retirement pay. Established by legislation enacted in 2021, this benefit allows 100% of qualifying retirement income to be subtracted from a taxpayer’s North Carolina adjusted gross income. This is a deduction, not a tax credit, which means it reduces the amount of income subject to tax rather than the tax liability itself.

Qualifying Income for the Deduction

The deduction applies to retirement pay from the U.S. Armed Forces. To be eligible, a retired member must have served at least 20 years or been medically retired under federal law. This tax benefit also extends to surviving spouses for payments received under the Survivor Benefit Plan (SBP). All qualifying income is only deductible to the extent it is included in the taxpayer’s federal adjusted gross income.

It is important to understand what income is not covered by this specific deduction. Distributions from the Thrift Savings Plan (TSP) are not considered military retirement pay and are subject to North Carolina income tax. Funds from civilian retirement accounts like 401(k)s or Individual Retirement Arrangements (IRAs), and severance pay, are also not eligible.

How to Claim the Deduction on Your Tax Return

To claim the military retirement deduction, you must file a North Carolina income tax return, Form D-400. You are required to file a state return if you meet the minimum gross income filing requirements for the tax year, even if all of your retirement income is excludable.

The specific form used to claim this deduction is North Carolina Schedule S, Supplemental Schedule. On this form, you will enter the total amount of your deductible military retirement pay on the designated line for subtractions from federal adjusted gross income. This amount should correspond to the taxable military retirement income reported on your federal return, which you would have received on Form 1099-R.

After calculating the total on Schedule S, that amount is transferred to Form D-400. You must attach a copy of the Form 1099-R you received from the Defense Finance and Accounting Service (DFAS) to your state tax return to support the deduction you are claiming. Failure to include this documentation can result in delays or denial of the deduction.