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

What Is a Reverse Morris Trust (RMT)?

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 without paying taxes on any gains made from the disposal.

A RMT is a form of organization that allows an entity to combine a subsidiary that was spun off with another company free of taxes, provided that all legal requirements for a spinoff are met. To form a RMT, 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.

How a Reverse Morris Trust (RMT) Works

RMTs originated as a result of a 1966 ruling in a lawsuit against the Internal Revenue Service, which created a tax loophole to avoid taxes when selling unwanted assets.

The RMT 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 RMT 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 RMT is that after its formation stockholders of the original parent company own at least 50.1% of the value and voting rights of the combined or 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.

It's also worth mentioning that the third-party company in a RMT has more flexibility in acquiring control of its board of directors and appointing senior management, despite holding a non-controlling stake in the trust.

Examples of a Reverse Morris Trust (RMT)

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 it 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.

Verizon then completed a RMT reorganization 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.

In another example, Lockheed Martin divested from its Information Systems & Global Solutions (ISGS) business segment in 2016. Like Verizon, it underwent a RMT by forming a new offshoot company that then merged with Leidos Holdings, 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. 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.