What I Learned the Hard Way About U.S. Tax on Interest Paid to Foreign Lenders?
By Leticia Balcazar 01-06-2026 1
I am not a tax professional. I am a business owner who invests across borders, and a few years ago I made an expensive mistake that I want to help other people avoid.
I had arranged a private loan to a friend's U.S.-based company. The terms were straightforward — a fixed interest rate, quarterly payments, a clear repayment schedule. I had used a lawyer to draw up the documents. I thought I had done everything right.
The first payment arrived and it was 30% lower than expected. I called my friend. He explained, slightly apologetically, that he had been advised to withhold a portion for the IRS. He was not wrong to do it. The problem was that nobody — not my lawyer, not his accountant, not the banker who facilitated the transfer — had warned either of us that this was coming.
That was my introduction to how U.S. tax on interest paid to foreign lenders actually works. And it cost me a significant amount of money before I figured out what I should have done differently.
The reasons behind this for so many foreign investors.
Under U.S. tax regulations, interest paid to foreign lenders is U.S.-source income. The pre-determined rule is 30% withholding tax which is deducted by the borrower before making any repayments. This rule is not generally known by most foreign lenders — and in fact, many U.S. borrowers — until it is already having an impact on them.
What makes this even more annoying is that in most cases the withholding can be avoided altogether. The U.S. tax code contains a straight provision for foreign lenders to be exempt from withholding the interest they receive, if they qualify. However, there is a need to be aware of it and there is a need to arrange the loan properly in advance of the money flow.
There are four points that would have protected me that I'm ensuring are in place with every loan I am involved in that crosses the border:
- The loan should be evidenced in registered form specifying the ownership.
- The interest rate should be set and/or some neutral market indicator, not based on borrower's profits or performance.
- The IRS will require the foreign lender to submit the proper IRS paperwork to prove they are not a U.S. lender prior to the first payment.
Foreign lender should not be the owner of the 10% or more voting shares of the borrowing company
If all of these conditions are met, the exemption is in effect and the 100% of the interest is paid to the lender, and not subject to U.S. tax. If one is missing, the borrower must withhold (and the lender bears the loss).
The One That Surprised Me
Once I located a specialist lawyer and arranged my loaning appropriately, she spoke to me of something that I hadn't even considered: estate tax exposure.
For foreign lenders, lending to U.S. companies is extremely poorly taxed in the U.S. — they can generally only exempt $60,000 of their lending from U.S. estate tax, whereas U.S. citizens can exempt millions of dollars of lending. If, in the event of my death, the loan itself might be a part of a taxable U.S. estate, without proper structuring.
Loans that may be eligible for the interest exemption are typically not considered to be a part of the U.S. estate for foreign lenders. That wasn't a factor I had been considering with respect to lending to American businesses. This would only come up when you are in the company of another who truly has his niche.
If I was going into the same situation, I would tell them the following…
The tax laws governing interest paid to foreign lenders in the U.S. are not clear. They are non-nonsense, specific and will not tolerate any mistakes at the outset of a transaction. It is difficult to get money back when it has been withheld without realizing anything was amiss.
Before you invest in an arrangement with a U.S. business, real estate or other entity where you are considering lending them money, make sure you get the structure right as a foreign investor. Not after.
The price of doing it right the first time is much cheaper than the price of doing it later — or, just not knowing how to do it, and to simply force the issue of withholding and go through the motions for years.
Frequently Asked Questions
Q: No, if there is a tax treaty between my country and the U.S. it does not automatically bar withholding.
A: Not automatically. Treaty benefits, in many cases, are available, but must be evaluated for eligibility and documented. Must submit proper IRS forms to the borrower prior to payment. If you don't have the correct paperwork or some paper is missing you will lose the treaty benefit even if you otherwise would qualify.
Q.If the U.S. borrower does not withhold and pays you the full amount, what will you do?
A: The borrower is responsible for the obligation to withhold, not the lender. The IRS will hold the borrower personally responsible for the unpaid taxes, plus interest and penalties, if he or she is not withheld when the IRS asks to do so. That's why it is important to have proper documentation before paying the foreign lender in full.
Q.If I reformulate my payments now can I get back any withheld tax?
A: Yes, perhaps, but you must take steps to file a U.S. tax return in order to get a refund, and there is a time limitation. It's not worth it if the sums involved are not great. An experienced international tax lawyer can help you decide if it is appropriate for you to file a tax refund action.
In collaboration with Leticia Balcazar
After my experience, I was referred to Leticia Balcazar, J.D., LL.M., Partner at Aliant Law. Her areas of specialism include structures for cross-border lending, qualification of interest, and withholding compliance for foreign investors in Asia, Europe and elsewhere. She has had her work cited in Bloomberg Tax and represents private lenders, family offices and international businesses that lend in to the U.S. market.
