TL;DR: Income a foreigner earns from actually doing business in the US. It gets taxed like a US person's income — and it means filing a US tax return.
Watch: What is ECI? (2 min, with captions) · Watch on YouTube

The US splits a foreign investor's US income into two buckets. ECI is the “you're running a business here” bucket: profits from an operating business, or from a fund that is itself treated as trading or lending in the US. Because a fund is usually a partnership, a foreign investor is treated as doing whatever the fund does — so if the fund is in a US business, so is every foreign LP.

ECI is taxed on a net basis at normal US rates (up to 37% for individuals, 21% for corporations), the foreign investor has to file a US return, and a foreign corporation can also owe a 30% branch profits tax on top. That filing obligation is the thing most foreign LPs want to avoid at almost any cost.

How ECI reaches a foreign investorA US operating LLC passes business profits up to a US fund, which passes them across the border to a foreign investor, who must file a US return.OUTSIDE THE USINSIDE THE USUS fund (partnership)looks through to its partnersPortfolio LLCruns a US businessForeign investore.g. German family officeFiles a US returntaxed at normal ratesbusiness profitsECI$$
Partnerships are see-through: if the fund is in a US business, its foreign partners are too.

Worked example

A German family office owns 10% of a US fund. The fund owns an LLC that runs a chain of car washes and earns $5m of profit. The family office's share — $500k — is ECI. The fund must withhold tax on it up front (see Section 1446), and the family office files a US return to settle up.

Where you'll see it: Fund docs promising to “use reasonable efforts to avoid ECI”, blocker structures, and Forms 8804/8805 at year-end.

Code: IRC §§ 864(c), 871(b), 882, 884 · Related: FDAP, Blocker, Section 1446 withholding, Season-and-sell

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This glossary is general information, simplified for learning. It is not tax, legal or investment advice, and real structures turn on facts and documents not shown here.