1. Retirement § 4 (NCI4th) — state and local government employees — retirement systems — contractual relationship — benefits exempt from state taxation The relationship between the retirement systems for state and local government employees and employees vested in the systems is contractual in nature. Furthermore, the right to retirement benefits exempt from state taxation is a term of such contract where the evidence showed the creation of various statutory tax exemptions by the legislature, the location of those provisions alongside the other statutorily created benefit terms instead of within the general income tax code, the frequency of governmental contract making, communication of the exemption by governmental agents in both written and oral form, use of the exemption as inducement for employment, mandatory participation, reduction of periodic wages by contribution amount, loss of interest for those not vesting, establishment of a set time period for vesting, and the reliance of employees upon retirement compensation in exchange for their services.

2. Taxation § 22 (NCI4th) — state and local government retirement benefits — exemption from taxation — not contracting away of taxing power The state tax exemption for state and local government retirement benefits does not constitute a contracting away of the State’s sovereign power of taxation in violation of Art. V, § 2(1) of the North Carolina Constitution. When subsection (1) of Art. V, § 2 is considered with subsections (3), (6), and (7), it is clear that the State may make contracts for exemptions without contracting away the power of taxation as long as the contract is for a public purpose, and the exemption was for a public purpose in that it helped attract and keep quality public servants despite the generally higher wages paid in private employment.

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3. Constitutional Law § 143 (NCI4th); Retirement § 4 (NCI4th) — retirement benefits — state and local government employees — cap on state tax exemption — impairment of contract The 1989 legislation which placed a $4,000 annual state tax exemption cap on retirement benefits received by state and local government employees impaired the contractual rights of employees whose retirement benefits had vested prior to passage of the legislation to a tax exemption for those benefits in violation of Art. I, § 10 of the United States Constitution.

4. Constitutional Law § 143 (NCI4th); Retirement § 4 (NCI4th) — retirement benefits — state and local government employees — cap on state tax exemption — not necessary for important public purpose Although the 1989 legislation which placed a $4,000 cap on the state tax exemption for retirement benefits received by state and local government employees was passed in response to a U.S. Supreme Court decision holding that federal retirees had to be treated the same as state and local retirees, the impairment of contracts caused by this legislation was neither reasonable nor necessary for achieving an important state interest since there are numerous ways in which the State could have complied with the decision without impairing any contract rights, including the exemption of federal benefits or application of the exemption cap prospectively only to those state and local employees whose retirement benefits had not yet vested. Therefore, the 1989 legislation was not an exercise of the police power or other means under which the State may legitimately skirt the mandate of the Contract Clause of Art. I, § 10 of the United States Constitution.

5. Constitutional Law § 110 (NCI4th); Retirement § 4 (NCI4th) — retirement benefits — state and local government employees — cap on state tax exemption — taking without just compensation The 1989 legislation which placed a $4,000 annual state tax exemption cap on retirement benefits received by state and local government employees constituted a taking without just compensation of the property of employees whose retirement benefits had vested in violation of the Fifth Amendment to the United States Constitution and Art. I, § 19 of the North Carolina Constitution where the employees had contracted, as consideration for their employment, that their retirement benefits, once vested, would be exempt from state taxation. U.S. Const. amend. V; N.C. Const. Art. I, § 19.

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6. Taxation § 219 (NCI4th) — retirement benefits — state and local government employees — income taxation — injunction improper — harmless error The trial court erred by enjoining the collection of income taxes on state and local government retirement benefits pursuant to the 1989 legislation which placed a $4,000 state tax exemption cap on those benefits since N.C.G.S. § 105-267 is the relevant statute for challenging the legislation, and the only relief granted under this statute is a refund of improperly collected taxes. However, this error was not prejudicial where the trial court immediately stayed the injunction pending appeal; the trial court determined that plaintiffs would still be required to file refund suits for years not covered by the present litigation; and the N.C. Supreme Court has determined in this appeal that the 1989 legislation is unconstitutional as applied to employees whose benefits vested prior to its passage so that the State will be prevented from further attempts to collect taxes on the benefits of those employees.

7. Costs § 29 (NCI4th) — class action — refund of income taxes on retirement benefits — common fund for attorney fees and costs In a class action in which it was held that the 1989 legislation which partially taxed state and local government retirement benefits was unconstitutional and that retirees whose benefits had vested are entitled to recover income taxes paid on those benefits by refunds or credits, the trial court did not err by ordering that fifteen percent of the refund or credit amount for each class member be paid to a common fund for the payment of the representative plaintiffs’ attorney fees and other costs and expenses. The recovery in this case constitutes a common fund for purposes of shifting attorney fees under the common fund doctrine.

8. Taxation § 216 (NCI4th) — retirement benefits — unconstitutional tax statute — refunds — compliance with protest statute not required Where it was determined that the 1989 statute which placed a $4,000 annual state tax exemption cap on retirement benefits received by state and local government employees unconstitutionally impaired contractual rights and constituted a taking of property without just compensation, the trial court erred by ordering that refunds be made only to those taxpayers who complied with the protest requirements of N.C.G.S. § 105-267 rather than to all taxpayers unconstitutionally taxed pursuant to the statute. To the extent that the decisions of Bailey v. State of North Carolina, 330 N.C. 227 (1991), and Swanson v. State of North Carolina, 335 N.C. 674 (1994) imply otherwise, they are disavowed.

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