Reverse Morris Trust (RMT)

A Reverse Morris Trust (RMT) is a tax-efficient transaction that lets a company divest unwanted assets or a business unit by spinning it off into a subsidiary and immediately merging that subsidiary with a third-party buyer. If structured to meet U.S. tax rules, the transaction can be completed without recognizing taxable gain on the sale.

How it works (step-by-step)

1. The parent company identifies assets or a business unit to divest and transfers them to a wholly owned subsidiary (or uses an existing subsidiary).
2. The parent company spins off that subsidiary, distributing its shares to the parent’s shareholders.
3. The spun-off subsidiary merges with the third-party buyer to form a new, unrelated company.
4. The original parent-company shareholders receive stock in the merged company and must control a majority of its voting power and economic value (generally at least 50.1%).
5. The parent company may also receive cash and/or debt securities as part of the deal.

When the ownership and other tax requirements are satisfied, the transaction is treated as a tax-free reorganization under Internal Revenue Code Section 355 rather than a taxable sale.

Key tax and legal points

• Tax-free treatment hinges on meeting IRC Section 355 and related IRS requirements (including ownership and business-purpose tests).
• Parent-company shareholders must retain control of the combined company (commonly defined as at least 50.1% of voting rights and economic interest).
• Because the parent’s shareholders must retain majority ownership, RMTs are most practical when the acquiring company is similar in size to, or smaller than, the spun-off subsidiary.
• Proper planning and legal documentation are essential to satisfy IRS rules and prevent unintended tax consequences.

Note: A plain Morris Trust differs in structure—under a Morris Trust the parent merges directly with the buyer without using a separate spun-off subsidiary.

Benefits

• Allows divestiture without immediate federal income tax on gain from the disposed assets.
• Enables the parent company to raise cash and reduce debt while avoiding a taxable sale.
• Can preserve or enhance shareholder value by combining the divested assets with a buyer better suited to operate them.
• Provides the buyer some flexibility in management and board arrangements even if it does not receive a controlling stake.

Limitations and considerations

• Complex and heavily regulated — requires careful tax and legal structuring.
• Not widely used each year due to the strict IRS requirements and the need for compatible deal economics.
• May be unattractive to large acquirers because the parent’s shareholders must end up with majority control of the merged company.
• Transactions must demonstrate valid business purpose beyond tax avoidance.

Examples

• Verizon and FairPoint (2007): Verizon transferred certain landline operations into a spun-off subsidiary and merged that subsidiary with FairPoint so Verizon shareholders held a majority stake in the combined business.
• Lockheed Martin and Leidos (2016): Lockheed spun off its ISGS business and combined it with Leidos; Lockheed shareholders held roughly 50.5% of the resulting company, and Leidos paid cash as part of the deal.
• AT&T and Discovery / WarnerMedia (2021–2022): AT&T used a spin-off/merge structure in the WarnerMedia–Discovery transaction, receiving cash and seeing its shareholders obtain a substantial stake in the new company.

When companies choose an RMT

Companies typically use an RMT to focus on core operations while monetizing or exiting non-core businesses in a tax-efficient manner. The structure is attractive when the combined ownership and business goals can satisfy IRS rules and the strategic fit between the spun-off unit and the buyer is strong.

Conclusion

An RMT is a specialized merger-and-spin-off structure that can transfer assets tax-free when strict legal and ownership conditions are met. It is a powerful option for companies seeking a tax-efficient divestiture, but it requires careful planning, compatible counterparties, and compliance with IRC Section 355 and related IRS guidance.