# Reverse Morris Trust (RMT): Definition, Benefits, and Tax Savings

## What Is a Reverse Morris Trust?

A Reverse Morris Trust (RMT) is a tax optimization strategy in which one company that wishes to sell assets to another company can do so without paying taxes on any gains made from the disposal.

The RMT requires that a parent company first spin off a subsidiary or other unwanted asset into a separate company. This entity is then merged with a firm that is interested in acquiring the asset.

### Key Takeaways

*   A Reverse Morris Trust (RMT) allows a company to [spin off](https://www.investopedia.com/terms/s/spinoff.asp) and sell [assets](https://www.investopedia.com/terms/a/asset.asp) while avoiding taxes.
*   The RMT starts with a parent company looking to divest itself of assets to a third-party company.
*   The [parent company](https://www.investopedia.com/terms/p/parentcompany.asp) transfers assets to a wholly owned [subsidiary](https://www.investopedia.com/terms/s/subsidiary.asp) and then spins off that subsidiary.
*   The subsidiary then merges with the third-party company.
*   After the RMT is formed, stockholders of the parent company own at least 50.1% of the value and voting rights of the merged firm.

## How a Reverse Morris Trust Works

RMTs originated as a result of a 1966 ruling in a lawsuit against the [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp), which created a tax loophole to avoid taxes when selling unwanted assets.

The RMT starts with a parent company that decides to divest itself of certain assets it no longer desires. It seeks to sell these assets to a third-party company.

The parent company either has an existing wholly owned subsidiary or creates one. It transfers the assets to the subsidiary. It then spins off or [splits off](https://www.investopedia.com/terms/s/split-off.asp) the subsidiary.

Next, the subsidiary and the third-party company [merge](https://www.investopedia.com/terms/m/merger.asp) to create an unrelated company. The unrelated company then issues shares to the original parent company’s [shareholders](https://www.investopedia.com/terms/s/shareholder.asp). The parent company can also receive debt securities and cash from the transaction.

If those shareholders control at least 50.1% of the voting rights and [economic value](https://www.investopedia.com/terms/e/economic-value.asp) in the unrelated company, the RMT is complete. The parent company has effectively transferred the assets, tax free, to the third-party company.

## Tax Savings

The RMT transaction provides a company (and its shareholders) with the opportunity to divest specific assets without receiving a tax bill. As part of the transaction, the company can receive cash and reduce its debt with no consequential [capital gains tax](https://www.investopedia.com/taxes/capital-gains-tax-101/).

A key tax avoidance feature of the RMT is that, after the formation of the merged and unrelated company, stockholders of the original parent company must own at least 50.1% of the shares and [voting rights](https://www.investopedia.com/terms/v/votingright.asp) of the merged firm.

This makes the RMT only attractive for third-party companies that are about the same size or smaller than the spun-off subsidiary.

To qualify for tax-free treatment, the transaction must meet the requirements set forth by Internal Revenue Code (IRC) Section 355.

> **Important**
>
> The difference between a Morris Trust and a Reverse Morris Trust is that with the former, the parent company merges directly with the target company and no subsidiary is used.

## Benefits of a Reverse Morris Trust

*   Companies (and their shareholders) can avoid a federal income tax liability on the sale of assets.
*   Shareholders can gain financial value from the divestiture of unwanted assets as well as the strategic merger of companies.
*   The third-party company has more flexibility in acquiring control of its [board of directors](https://www.investopedia.com/terms/b/boardofdirectors.asp) and appointing senior management, despite holding a noncontrolling stake in the trust.

## Examples of a Reverse Morris Trust

*   A [telecom company](https://www.investopedia.com/articles/markets/030216/worlds-top-10-telecommunications-companies.asp) wishes to sell old landlines to smaller companies in rural areas because it doesn’t want to spend the time or resources required to upgrade those lines to broadband or fiber-optic lines.

In 2007, Verizon Communications ([VZ](https://www.investopedia.com/markets/quote?tvwidgetsymbol=VZ)) announced a planned sale of certain landline operations in the Northeast to FairPoint Communications. To meet the tax-free transaction qualification, Verizon transferred unwanted landline operation assets to a separate subsidiary and distributed its shares to its existing shareholders.

Verizon then completed the RMT transaction with FairPoint that gave the original Verizon shareholders a majority stake in the newly merged company and FairPoint’s original management the green light to run the newly formed business.

*   [Lockheed Martin](https://www.investopedia.com/articles/markets/102715/how-lockheed-martin-makes-its-money-lmt.asp) ([LMT](https://www.investopedia.com/markets/quote?tvwidgetsymbol=LMT)) divested its Information Systems & Global Solutions (ISGS) business segment in 2016. Like Verizon, it used the RMT by forming a new offshoot company that then merged with Leidos Holdings ([LDOS](https://www.investopedia.com/markets/quote?tvwidgetsymbol=LDOS)), a defense and information technology company.

Leidos Holdings paid a $1.8 billion cash payment, while Lockheed Martin reduced approximately 3% of its outstanding [common shares](https://www.investopedia.com/terms/c/commonstock.asp). Lockheed Martin stockholders involved in the transaction then owned a 50.5% stake in Leidos. Overall, the transaction was valued at an estimated $4.6 billion.

*   [AT&T](https://www.investopedia.com/insights/how-att-makes-money/) ([T](https://www.investopedia.com/markets/quote?tvwidgetsymbol=T)) [agreed to spin off](https://www.investopedia.com/at-and-t-and-discovery-to-merge-media-assets-in-mega-deal-5185046) its Warner Media division in a megadeal with Discovery in 2021. Using an RMT, AT&T received $40.4 billion in cash and WarnerMedia’s retention of certain debt.

The deal, which closed in 2022, created Warner Bros. Discovery ([WBD](https://www.investopedia.com/markets/quote?tvwidgetsymbol=WBD)), a new business separate from AT&T. AT&T shareholders received a 71% stake and appointed seven board members.

## How Does a Reverse Morris Trust Work?

A Reverse Morris Trust is a strategic way to divest a division tax-free, provided that all legal requirements are met under IRC Section 355. To use a Reverse Morris Trust, a company will create a subsidiary (or use an existing one) for this division, then merge it with another company. Importantly, shareholders of the parent company must own over 50% of the newly created company.

## Why Do Companies Choose a Reverse Morris Trust?

When a company wants to focus on its core operations by selling assets in a tax-efficient manner, it may choose a Reverse Morris Trust. This allows the parent company to raise money and reduce its debt while selling unwanted business assets. It also avoids paying federal income taxes on the transfer of assets.

## Are Reverse Morris Trusts Commonly Used?

Only a few Reverse Morris Trusts are used each year. Part of the reason for this is that certain IRS requirements apply to RMTs, such as only certain companies can apply and they must have generated positive income in the five years prior to the transaction.

## The Bottom Line

A Reverse Morris Trust is a transaction in which one company sells off unwanted assets by transferring them to a subsidiary and immediately merging that subsidiary with a third-party company that wants to buy it. The parent company and its shareholders incur no federal income tax liability as a result.

The RMT offers a tax-efficient way to create value for shareholders of the parent company as well as the third-party company.

> **Article Sources**
>
> 1.  The Wall Street Journal. “[What’s a ‘Reverse Morris Trust’ and Why Is Everybody Doing One?](https://www.wsj.com/articles/BL-MBB-34994)”
>     
> 2.  Internal Revenue Service. “[Section 355—Distribution of Stock and Securities of a Controlled Corporation](https://www.irs.gov/pub/irs-drop/rr-03-79.pdf).”
>     
> 3.  Thomas. “[Verizon and FairPoint Agree to Merge Verizon’s Wireline Businesses in Maine, New Hampshire and Vermont with Current Operations of FairPoint](https://news.thomasnet.com/companystory/verizon-and-fairpoint-agree-to-merge-verizon-s-wireline-businesses-in-maine-new-hampshire-and-vermont-with-current-operations-of-fairpoint-505239).”
>     
> 4.  Lockheed Martin News & Events. “[Lockheed Martin Successfully Closes Transaction to Separate and Combine IT and Technical Services Businesses with Leidos](https://news.lockheedmartin.com/2016-08-16-Lockheed-Martin-Successfully-Closes-Transaction-to-Separate-and-Combine-IT-and-Technical-Services-Businesses-with-Leidos).”
>     
> 5.  The Hollywood Reporter. “[‘Taxes Destroy Value’: Why AT&T Is Using a Reverse Morris Trust in the WarnerMedia-Discovery Deal](https://www.hollywoodreporter.com/business/business-news/att-reverse-morris-trust-warnermedia-discovery-deal-1235044979/).”
>     
> 6.  Warner Bros. Discovery. “[Discovery and AT&T Close WarnerMedia Transaction](https://www.wbd.com/discovery-and-att-close-warnermedia-transaction).”