Tax Loopholes That Could Save You Money

A tax loophole allows individuals and companies to lower their tax liability using a provision or ambiguity in tax law. Loopholes are legal and allow income or assets to be moved with the purpose of avoiding taxes. This is different from lesser-known tax deductions or strategies that are intentionally available for taxpayers to save money. Let’s break down how loopholes work, common examples, and how they differ from intended tax-saving strategies.

A financial advisor with tax expertise can help you optimize your finances and potentially lower your tax liability.

What Makes a Tax Loophole?

4 Examples of Tax Loopholes

There are multiple provisions and strategies that taxpayers may use to reduce taxes legally. Here are four commonly discussed examples.

1. Carried Interest Loophole

If you’re a hedge fund manager, venture capitalist or partner in a private equity firm, some carried interest may qualify for long-term capital gains treatment rather than being taxed at ordinary income tax rates. However, special holding-period rules apply. Carried interest generally must meet a three-year holding period to receive long-term capital gains treatment under federal tax rules. ¹

Carried interest generally represents a share of a partnership’s profits received for providing investment management services. When the applicable requirements are met, gains allocated through that interest can receive long-term capital gains treatment.

2. Backdoor Roth IRAs

For tax year 2026, direct Roth IRA contributions begin phasing out at modified adjusted gross income (MAGI) of $153,000 for single filers and heads of household and $242,000 for married couples filing jointly. Direct contributions stop once MAGI reaches $168,000 for single filers or $252,000 for married couples filing jointly. These income limits restrict access to tax-free growth for higher earners. ²

A backdoor Roth IRA is a strategy that works around these limits by using two steps. First, an individual makes a nondeductible contribution to a traditional IRA, which has no income restrictions. Then, they convert those funds into a Roth IRA because income limits apply to contributions but not conversions. This approach allows higher-income taxpayers to move money into a Roth account.

While this process involves a Roth conversion, it differs from a typical Roth conversion. A standard Roth conversion usually involves moving pre-tax retirement savings into a Roth IRA. Then you’d pay income tax on the converted amount. In contrast, a backdoor Roth IRA converts after-tax contributions with little or no additional tax. That also depends on whether the investor has other pre-tax IRA balances.

The strategy is considered legal because it follows existing tax rules rather than avoiding them. However, if you have other pre-tax IRA assets, the conversion may be partially taxable under the pro-rata rule. When used carefully, this approach can allow retirement savings to grow tax-free and avoid required minimum distributions (RMDs) during the account holder’s lifetime.

3. Foreign-Derived Intangible Income (FDII)

For tax years beginning after Dec. 31, 2025, the tax code replaced the former foreign-derived intangible income (FDII) framework with foreign-derived deduction eligible income (FDDEI). Under the revised rules, qualifying domestic corporations can generally deduct 33.34% of FDDEI. This generally includes eligible income connected with certain property sold to foreign customers for foreign use or services provided to customers or property outside the United States. ³

4. Step Up in Basis

The step-up in basis is a tax concept that some view as a strategic benefit rather than a loophole. It allows the value of an inherited asset to be recalculated. The IRS bases it on its market price at the time of the previous owner’s death. This recalibration effectively erases the unrealized capital gains accumulated during the deceased owner’s lifetime. This means heirs may face little to no capital gains tax if they sell the asset shortly after inheriting it. ⁴

Proponents suggest this rule prevents taxation on wealth that has already been taxed indirectly through income or other means. However, critics argue it creates an uneven playing field. It largely aids wealthier families and encourages asset retention until death to minimize tax exposure.

6 Tax Credits for All Taxpayers

The government has also drafted legislation that intentionally helps taxpayers save money. Unlike tax loopholes, this legislation is often drafted as a part of a social safety net or a relief package that aims to stimulate the economy. Here are six common tax credits that save taxpayers money.

1. Saver’s Tax Credit

Working-class Americans who manage to put together some savings can claim the Saver’s Tax Credit when they fill out their returns. The government designed this tax break to give people an incentive to save money. This is especially important because so many people lack an emergency fund and have zero or insufficient retirement savings. The Saver’s Tax Credit is not refundable. It can reduce your tax bill to zero, but if the amount of your credit exceeds what you owe the IRS it won’t refund the difference to you. ⁵

2. Earned Income Tax Credit

If you have a job but it’s not bringing in much income you can claim the Earned Income Tax Credit (EITC). Like any tax credit, the EITC directly reduces your tax bill by the size of the credit. Unlike the Saver’s Tax Credit, the EITC is refundable. If the amount of the EITC exceeds the amount you owe the IRS, it will refund the difference to you. The EITC has been very successful in reducing poverty among working-class families. ^{6 7}

3. American Opportunity Tax Credit

The American Opportunity Tax Credit provides a $2,500 tax credit for eligible students participating in a higher education program after high school. You get 100% of the credit on your first $2,000 of annual educational expenses and 25% of the credit on the next $2,000, $500 total, in expenses per student. ⁸

Even if the qualifying educational expenses are more than $4,000 per year, you can only receive a maximum credit of $2,500 per year for each student for a maximum of four years. The credit is also partially refundable if the credit ultimately brings your total tax bill to $0. In this case, you may be able to receive up to 40% of the credit amount (up to $1,000) refunded to you.

Want to see the potential effect of tax credits? Get an estimate with our income tax calculator below.

4. Lifetime Learning Credit

The Lifetime Learning Credit is for qualified tuition and related expenses paid for eligible students enrolled in an eligible educational institution. This credit can help pay for undergraduate, graduate and professional degree courses (including courses to acquire or improve job skills). There is no limit on the number of years you can claim the credit. It is worth up to $2,000 per tax return.

5. Child Tax Credit

This credit gives an income boost to the parents or guardians of children and other dependents. The credit is worth up to $2,200, up to $1,700 of which is refundable in 2026. The credit phases out for wealthier families. ⁹

6. Child and Dependent Care Credit

The Child and Dependent Care Credit helps reduce your tax liability when you pay for care so you can work or look for work. Qualifying expenses may include day care, preschool, after-school programs, or in-home care for a child under age 13. It can also apply to care for a spouse or dependent who is physically or mentally unable to care for themselves.

The credit is nonrefundable and calculated as a percentage of eligible expenses, subject to annual limits. While it does not create a refund beyond what you owe, it can lower your overall tax bill, particularly for households with ongoing child care or dependent care costs. ¹⁰

How to Use Tax Breaks Without Crossing the Line

Readers looking for tax loopholes may also encounter aggressive strategies that are very different from claiming deductions, credits, and other benefits allowed by law. Legal tax planning uses the tax code as written, while tax evasion involves actions such as deliberately concealing income, claiming expenses you never incurred, or providing false information on a tax return.

A practical way to evaluate a tax-saving strategy is to identify the specific rule that permits it and keep records supporting the transaction. For example, contributing to an eligible retirement account, claiming a credit for qualifying expenses or completing a properly reported Roth conversion can reduce current or future taxes within established rules. Creating a transaction that exists only on paper or omitting taxable income can create a different tax result and potential penalties.

Tax rules can also change after a strategy becomes widely used. The federal treatment of foreign-derived corporate income changed for tax years beginning in 2026, for example, while annual retirement contribution and income limits can change from year to year. Checking the rules that apply to the specific tax year can help distinguish a currently available strategy from one that the IRS has restricted or eliminated.

Bottom Line

Tax loopholes are provisions in the tax code that allow taxpayers to lower their tax liability. These loopholes occur accidentally, created by shortcomings in legislation that were not obvious when drafted. Many loopholes close over time eventually. But the tax code is so complex that things will always slip through the cracks. If you’re interested in lowering your tax burden, a financial advisor can help you take advantage of common tax deductions and strategies that have been intentionally created by legislation to benefit taxpayers.

Tips for Navigating Tax Season

• A financial advisor can be a key resource in helping you figure out your tax situation. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• If you don’t know whether you’re better off with the standard deduction versus itemized, you might want to read up on it and do some math. Educating yourself before the tax return deadline could help you save a significant amount of money.
• SmartAsset has you covered with a number of free online tax resources to help you during tax season. Check out our income tax calculator and get started today.

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