An RMT is a corporate tax‑planning technique that lets a company divest a business or asset to a third party while avoiding immediate federal income tax on the gain from that disposition. It accomplishes this by spinning the divested business into a subsidiary and then merging that subsidiary with an acquiring company in a transaction that leaves the original parent’s shareholders owning a majority of the merged entity. If structured to meet the requirements of Internal Revenue Code Section 355 (and related rules), the transaction can be treated as tax‑free to the distributing parent and its shareholders.
Key features (at a glance)
– Parent spins a subsidiary that holds the unwanted business/asset.
– The spun‑off subsidiary merges with a third‑party acquirer.
– The parent’s shareholders must own a majority (typically cited as at least 50.1%) of the merged company’s voting power and economic value.
– The deal must satisfy IRC Section 355 requirements (active‑business tests, not a “device” to distribute earnings, business purpose, etc.).
– RMTs are most attractive when the acquirer is approximately the same size or smaller than the spun‑off business (so parent shareholders can be majority owners post‑merger).
(Sources: Investopedia; IRS Section 355)
How an RMT works — step‑by‑step (practical)
1. Identify the divestiture target
• Choose the business or assets the parent wants to dispose of.
2. Form or select a subsidiary
• Transfer the target assets/operations into a wholly owned subsidiary (if one doesn’t already exist).
3. Meet pre‑distribution ownership/control tests
• Ensure the parent “controls” the subsidiary immediately before distribution. (Under the tax rules governing reorganizations, “control” is generally interpreted under Section 368(c) — often an 80% ownership threshold of voting power and value for the controlled corporation prior to distribution.) [See IRS Section 355]
4. Spin off the subsidiary to the parent’s shareholders
• The parent distributes the subsidiary’s stock to its shareholders in a spin‑off (or split‑off) such that shareholders receive shares in the subsidiary.
5. Merge the spun‑off subsidiary with the acquirer
• The spun‑off subsidiary merges into the third‑party acquirer (or vice‑versa), creating a single, combined company.
6. Structure post‑merger ownership so parent shareholders are majority owners
• The crucial tax requirement for an RMT: the original parent’s shareholders must hold a majority (commonly a minimum of 50.1%) of voting power and economic interest in the merged company. The parent company itself can receive cash and/or debt securities as part of the arrangement.
7. Close, integrate, and document
• Obtain necessary shareholder approvals, regulatory clearances (antitrust, sector regulators), and finalize all tax and legal documentation. File required securities and tax notices.
Why the ownership threshold matters
– The requirement that the parent’s shareholders be majority owners of the merged company is what makes it a “reverse” Morris Trust: the formerly spun‑off business ends up controlled, in the hands of the parent’s shareholders, so the IRS treats the series of steps as a tax‑free distribution/merger under Section 355 rather than a taxable sale.
– Practically, that means the acquirer is often smaller than — or at least not overwhelmingly larger than — the business being spun off, because the buyers must accept a post‑deal ownership structure where their original shareholders are not the controlling block.
Legal and tax requirements (high‑level)
– IRC Section 355: The distribution must satisfy the statutory tests and related regulations. Key elements include:
• Control: the distributing corporation must have had the requisite control of the subsidiary before the distribution (see Section 368(c) “control” rules).
• Active business test: both the distributing and the distributed entity generally must be engaged in an active trade or business immediately after the distribution, and the businesses generally should have been active for at least five years (the “five‑year active business” requirement as applied in practice).
• Device test: the transaction must not be principally a device to distribute earnings and profits to shareholders.
• Business purpose: there must be a valid corporate business purpose for the transaction (not solely tax avoidance).
– State/foreign taxes and securities/antitrust laws: federal income tax is the primary focus, but state income taxes and non‑tax regulatory approvals can affect timing, structure, and economics.
(Primary legal source: IRS Section 355 — Distribution of Stock and Securities of a Controlled Corporation)
Benefits of an RMT
– Tax efficiency: can transfer assets without recognizing immediate taxable gain at the parent level if requirements are satisfied.
– Preserve enterprise and shareholder value: enables divestiture without the drag of tax liabilities that would arise in a straight cash sale.
– Flexibility in consideration: parent can receive cash, debt securities, and end up with its shareholders holding a controlling stake in the combined company.
– Attractive in carve‑outs where parent wants to reduce debt or raise cash while keeping shareholder value intact.
(Sources: Investopedia; practice examples below)
Drawbacks, limits and risks
– Complexity and cost: structuring an RMT requires detailed tax and legal analysis, negotiation, and transaction costs that can be substantial.
– IRS scrutiny: the transaction must meet Section 355 tests (business purpose, active business, not a device), and the IRS may challenge aggressive positions.
– Buyer limitations: the requirement that parent shareholders own majority of the merged company makes RMTs unattractive to large acquirers that would not want to cede control; buyers must be of suitable size or be willing to accept minority control.
– Timing and restrictions: businesses must meet active‑business history requirements and other doctrine constraints; transactions can be disrupted if documentation is deficient.
– Possible state and foreign tax consequences despite federal tax relief.
(Sources: Investopedia; IRS)
When and why companies use an RMT
– A parent company that wants to divest a non‑core division but avoid paying federal income tax on the gain may choose an RMT. That can be especially attractive when the divestiture unit is large enough that a straight sale would trigger large taxes and materially reduce proceeds to shareholders. The RMT lets the parent raise cash or reduce debt while preserving shareholder value and avoiding an immediate federal tax bill — provided the transaction meets the legal tests. (See real‑world examples below.)
How common are RMTs?
– Not very common. Only a handful are completed annually. Reasons include the stringent Section 355 requirements, the buyer‑size constraint (so that parent shareholders can retain a post‑deal majority), costs/complexity, and regulatory oversight. When they do occur, they are usually high‑profile corporate restructurings. (Sources: Investopedia; Wall Street Journal)
Practical checklist for management considering an RMT
1. Early assessment
• Confirm strategic rationale (why spin and merge rather than ordinary sale).
• Engage tax and external legal counsel experienced in Section 355 and M&A tax planning.
2. Tax and accounting due diligence
• Verify whether the businesses meet the “active trade or business” tests and the five‑year lookback considerations.
• Model the tax consequences of alternatives (straight sale, spinoff, RMT) to quantify economic benefit.
3. Structuring
• Create/confirm the subsidiary that will hold the divested assets.
• Negotiate with prospective acquirers terms that permit parent shareholders to own >50% of the combined business (deal price, share exchange ratios, required cash consideration, debt allocations).
4. Documenting business purpose and anti‑abuse protections
• Build contemporaneous support for non‑tax business purpose(s).
• Structure to avoid failing the “device” test (e.g., avoid distributions that look like dividend substitutes).
5. Regulatory, corporate and shareholder approvals
• Prepare required board and shareholder resolutions and disclosure documents.
• Plan for antitrust/industry regulator filings, as applicable.
6. Obtain tax opinions and consider advance clearance
• Obtain a formal tax opinion to support Section 355 treatment; consider whether any administrative relief (rare) or other IRS interaction is advisable.
7. Execution and filings
• Complete the spin, the merger, and required securities and tax filings (SEC notices/8‑K filings where applicable).
• Post‑closing, monitor and document ongoing compliance in case of IRS inquiry.
Examples (notable RMT transactions)
– Verizon and FairPoint (announced 2007): Verizon spun off its New England landline operations into a subsidiary and completed an RMT with FairPoint so that Verizon shareholders had a majority stake in the resulting combined company while Verizon effected the divestiture on a tax‑efficient basis. [Verizon; Investopedia summary]
• Lockheed Martin and Leidos (separation/combination of IT and technical services): In the transaction, Leidos paid cash while Lockheed shareholders ended up owning a slight majority of the combined business (reported as a 50.5% stake). The deal was structured to separate and combine businesses for strategic and tax reasons. [Lockheed Martin]
• AT&T and WarnerMedia/Discovery (2022): AT&T used an RMT‑style approach in separating WarnerMedia and combining it with Discovery to form Warner Bros. Discovery; AT&T shareholders received a significant stake in the new entity (reported as 71% in the cited coverage), enabling a tax‑efficient separation and combination of media assets. [Warner Bros. Discovery; Hollywood Reporter]
Note: the precise mechanics, percentages, and cash/debt flows differ in each transaction; these examples illustrate the RMT concept in practice. (Sources: Investopedia; corporate press releases; news reports)
The bottom line
A Reverse Morris Trust is a specialized and effective structure for accomplishing a tax‑efficient divestiture when the right strategic, legal, and transactional conditions exist. It can preserve more value for shareholders than a taxable sale, but it is complex, costly to implement, and constrained by IRS rules and buyer size considerations. Companies thinking about an RMT should engage experienced tax and legal advisors early, run alternative scenarios, and document business purposes and compliance carefully.
Primary sources and further reading
– Investopedia: “Reverse Morris Trust” (original source provided)
– Internal Revenue Service: Section 355 — Distribution of Stock and Securities of a Controlled Corporation (statutory/regulatory authority)
– Corporate press releases and news articles cited in many RMT examples: Verizon and FairPoint announcement; Lockheed Martin–Leidos transaction documents; Warner Bros. Discovery closing notices; Wall Street Journal coverage on RMT usage.
Editor’s note: The following topics are reserved for upcoming updates and will be expanded with detailed examples and datasets.