Do interest limitation rules apply to a foreign-owned single-member LLC with intercompany loans?

For a single-member LLC owned by a foreign corporation and treated as a disregarded entity, the LLC's activities are attributed to the foreign corporation for tax purposes. If the foreign corporation is engaged in a U.S. trade or business through the LLC (generating effectively connected income), the Section 163(j) limitation applies at the foreign corporation level on Form 1120-F. The interest expense on the intercompany loan is part of the foreign corporation's ECI deductions and is subject to the 30% ATI limitation. If the foreign owner is an individual filing Form 1040-NR, the same analysis applies — interest expense allocable to ECI is subject to 163(j).

A critical threshold question is whether a loan from a foreign owner to its own disregarded entity LLC is respected as a loan for U.S. tax purposes. Since the LLC is disregarded, the foreign owner and the LLC are treated as the same taxpayer. A taxpayer cannot lend money to itself. Under Treasury Regulations Section 301.7701-2(c)(2)(i), some transactions between a disregarded entity and its owner are disregarded for federal tax purposes, while others (like those reportable on Form 5472) are treated as transactions for reporting purposes. Whether the interest deduction is available at all depends on whether the debt is respected — and interest paid to oneself is generally not deductible. Consult your tax advisor on this fact-specific issue.

If instead the loan is from a foreign parent corporation to a U.S. LLC that is owned by a separate foreign subsidiary (making the LLC a disregarded entity of the subsidiary, not the lender), the loan is between two separate taxpayers and the interest deduction is generally available (subject to arm's-length requirements and Section 163(j)). Similarly, if the LLC is a multi-member entity treated as a partnership, loans from a foreign member are between separate taxpayers and interest may be deductible.

Interest paid to a foreign person (whether an individual or corporation) from U.S. sources is generally subject to 30% withholding tax under IRC 1441/1442, unless an exception or treaty reduction applies. Common exceptions include the portfolio interest exemption (IRC 871(h)/881(c)) for interest on registered obligations not owned by a 10%-or-greater shareholder, and treaty-based reductions (many treaties reduce the withholding rate on interest to 0-15%). The LLC (or the withholding agent) must file Form 1042 and Form 1042-S to report the interest and any withholding. The foreign recipient must provide Form W-8BEN or W-8BEN-E to claim treaty benefits.

Even if the interest deduction is limited or disallowed, reporting is still required. The LLC must report the intercompany loan and interest payments on Form 5472 as reportable transactions with a foreign related party. If withholding tax applies, Form 1042 (annual return) and Form 1042-S (information return for the foreign recipient) must be filed. If claiming a Section 163(j) limitation, Form 8990 is filed with the tax return. Failure to report intercompany transactions on Form 5472 carries a $25,000 penalty per form, per year.