What Is a Reverse Morris Trust?

A reverse Morris trust (RMT) is a tax-optimization strategy in which a company wishing to spin-off and subsequently sell assets to an interested party can do so while avoiding taxes on any gains from such asset disposal.

A reverse Morris trust is a form of organization that allows an entity to combine a subsidiary that was spun off with a strategic merger or combination with another company free of taxes, provided that all legal requirements for spinoff are met. To form a reverse Morris trust, a parent company must first spin-off a subsidiary or other unwanted asset into a separate company, which is then merged or combined with a firm that is interested in acquiring the asset.

Key Takeaways

  • A reverse Morris trust (RMT) allows a company to spin-off and sell assets while avoiding taxes.
  • The reverse Morris Trust starts with a parent company looking to sell assets to a third-party company.
  • After a reverse Morris trust is formed, stockholders of the original company own at least 50.1% of the stock by vote and value of the combined or merged firm.

How a Reverse Morris Trust Works

Reverse Morris trusts originated as a result of a 1966 ruling in a lawsuit against the Internal Revenue Service (see C.I.R. v. Morris Trust), which created a tax loophole to avoid taxes when selling unwanted assets.

The reverse Morris trust starts with a parent company looking to sell assets to a third-party company. The parent company then creates a subsidiary, and that subsidiary and the third-party company merge to create an unrelated company. The unrelated company then issues shares to the original parent company's shareholders. If those shareholders control at least 50.1% of the voting right and economic value in the unrelated company, the reverse Morris Trust is complete. The parent company has effectively transferred the assets, tax-free, to the third-party company.

The key feature to preserve the tax-free status of a reverse Morris trust is that after its formation, stockholders of the original parent company own at least 50.1% of the stock by vote and value of the combined or merged firm. This makes the reverse Morris trust only attractive for third-party companies that are about the same size or smaller than the spun-off subsidiary.

Also, the third-party company in a reverse Morris trust has more flexibility in acquiring control of its board of directors and appointing senior management, despite a non-controlling stake in the trust.

The difference between a Morris trust and a reverse Morris trust is that in a Morris trust, the parent company merges with the target company and no subsidiary is created.

Example of a Reverse Morris Trust

A telecom company that wishes to sell old landlines to smaller companies in rural areas could use this technique. The telecom company might not wish to spend the time or resources to upgrade those lines to broadband or fiber-optic lines, so they could sell those assets using this tax-efficient transfer.

In 2007, Verizon Communications announced a planned sale of its landline operations in certain lines in the Northeast region 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.

Then, Verizon completed a reverse Morris trust reorganization with FairPoint, under which the original Verizon shareholders owned a majority stake in the newly merged company, while FairPoint's original management ran the new company.