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What Is a Reverse Morris Trust?
Let me explain what a Reverse Morris Trust, or RMT, really is. It's a tax optimization strategy where a company looking to sell assets to another can do that without paying taxes on the gains from the sale.
In this setup, you start with a parent company that spins off a subsidiary or unwanted asset into its own separate entity. Then, that entity merges with the company interested in acquiring the asset.
Key Takeaways
Here's what you need to know directly: An RMT lets a company spin off and sell assets while dodging taxes. It begins with a parent company wanting to divest assets to a third party. The parent transfers those assets to a wholly owned subsidiary and spins it off. Next, the subsidiary merges with the third-party company. Finally, after the RMT, the parent company's stockholders own at least 50.1% of the value and voting rights in the merged firm.
How a Reverse Morris Trust Works
RMTs came about from a 1966 ruling in a lawsuit against the IRS, which opened up this tax loophole for selling unwanted assets without taxes.
You have a parent company deciding to get rid of certain assets it doesn't want anymore and sell them to a third-party company. The parent either uses an existing wholly owned subsidiary or creates one, transfers the assets there, and then spins off or splits off that subsidiary.
After that, the subsidiary merges with the third-party company to form an unrelated company. This new company issues shares to the original parent’s shareholders, and the parent might also get debt securities and cash.
If those shareholders control at least 50.1% of the voting rights and economic value in this unrelated company, the RMT is done. The parent has transferred the assets tax-free to the third party.
Tax Savings
The big draw of an RMT is the tax savings for the company and its shareholders when divesting assets. You can receive cash and cut debt without facing capital gains tax.
A crucial part is that after the merger, the original parent’s stockholders must own at least 50.1% of the shares and voting rights in the new firm. This makes RMTs appealing mainly for third-party companies that are similar in size or smaller than the spun-off subsidiary.
For tax-free status, the whole transaction has to meet the rules in Internal Revenue Code Section 355. Remember, the difference from a regular Morris Trust is that here, no subsidiary is used—the parent merges directly with the target.
Benefits of a Reverse Morris Trust
Companies and their shareholders avoid federal income tax on asset sales. Shareholders get value from divesting unwanted assets and from the merger itself. The third-party company gains flexibility in controlling the board and management, even with a noncontrolling stake.
Examples of a Reverse Morris Trust
Consider a telecom company wanting to sell old landlines to smaller rural firms because upgrading them to broadband isn't worth the effort.
In 2007, Verizon transferred unwanted landline assets to a subsidiary, spun it off to shareholders, and merged it with FairPoint. This gave Verizon shareholders majority stake, and FairPoint's team ran the new business tax-free.
Lockheed Martin used an RMT in 2016 to divest its ISGS segment by spinning it off and merging with Leidos. Leidos paid $1.8 billion cash, Lockheed reduced shares, and its stockholders got 50.5% of Leidos in a $4.6 billion deal.
AT&T spun off WarnerMedia in 2021 via RMT, merging it with Discovery to form Warner Bros. Discovery. AT&T got $40.4 billion cash and debt retention, with shareholders holding 71% stake and appointing board members.
How Does a Reverse Morris Trust Work?
It's a way to divest a division tax-free if you meet IRC Section 355 rules. You create or use a subsidiary for the division, then merge it with another company, ensuring parent shareholders own over 50% of the new entity.
Why Do Companies Choose a Reverse Morris Trust?
When focusing on core operations, companies pick RMT to sell assets tax-efficiently. It raises money, reduces debt, and avoids taxes on asset transfers.
Are Reverse Morris Trusts Commonly Used?
Not really—only a few happen each year. IRS requirements limit them, like needing positive income for five years prior and restrictions on which companies qualify.
The Bottom Line
In an RMT, a company sells unwanted assets by moving them to a subsidiary and merging it right away with a buyer. No federal income tax hits the parent or shareholders. It's a straightforward tax-efficient method to create value for everyone involved.
