"Correct" interest rate

W is Grantor of Irrevocable Trust with H as beneficiary. So Trust income reported on their joint tax return. Trust set up a Single Member LLC (SMLLC) with the trust as the only member. So the SMLLC is a disregarded entity and any income still reported on the joint tax return - so far so good. The LLC is making a home-equity loan to the H&W. So mortgage interest will be paid by H&W to trust. I am pretty sure that since the SMLLC and the H&W are the same tax entity - there is neither mortgage interest income (to SMLLC) or a mortgage interest deduction (to the H&W) - since they are paying this to themselves. So far so good.

But what is the "correct" interest rate? I know there is something called the Applicable Federal Rate interest rate. Is that applicable here? Also I believe this AFR is a minimum rate? Can the actual rate charged by the LLC be higher? Again - no matter the rate I don't believe it would result in interest income or interest expense.

You say, "So trust income is reported on their joint return." That does not necessarily follow. Is it because it's a grantor trust? Or that the trust distributes all its income to H? Or for some other reason?

Why in the world would you want to do that?

Right, in theory.

A minimum interest rate is required to be charged on loans, and the IRS recalculates the rate every month. But (assuming you are correct that they are just paying themselves) that shouldn't apply because there is no interest income or interest deduction.

Yes, the rate can be higher, if allowed under local law.

The problem is to understand why you are doing this. If this transaction is seen by the IRS to somehow distort your income or evade taxes, they may want to recalculate your income and taxes in a way they think more accurately reflects the reality of your situation.