Taxpayers Lessie Dunn and Erwin Cook Jr., had argued it was unconstitutional for North Carolina to tax income from out-of-state bonds while exempting income from in-state bonds.
Their lawsuit — which was expanded to a class-action lawsuit to include all such taxpayers — sought refunds for all individuals, companies and entities who had paid such taxes since 2000.
North Carolina officials had said the refunds sought would be difficult to calculate and could harm the state's ability to balance its budget. A 2004 legislative report estimated the refunds could cost the state $150 million.
But Forsyth Superior Court Judge R. Stuart Albright dismissed the case in light of a U.S. Supreme Court ruling in May.
In a 7-2 decision on a case from Kentucky, the high court ruled that states can exempt interest generated on their own bonds from taxes while taxing residents for interest on out-of-state bonds.
"Because of the Supreme Court decision, there was no hope for this case," said Greensboro lawyer Norman Smith, who represented the taxpayers in the North Carolina class-action lawsuit. The lawsuit was filed in 2004.
The court's majority opinion said the state's tax exemptions on bonds used to fund roads, construction and other projects had not injured commerce between states.
That decision calmed the fears of some industry groups, which warned that ending the long-standing practice could cause turmoil in the municipal bond market, and doomed the North Carolina lawsuit.
Dozens of states, including North Carolina, have tax systems similar to Kentucky.
An attorney for the state did not respond to messages seeking comment left through the Department of Revenue.