If your spouse is a U.S. citizen, you can leave him or her an unlimited amount when you die with no estate tax. But this can be a tax trap, because it wastes an exemption.
Let's say, for example, that Bob and Sue together have a net estate of $7 million and they both die in 2009. Bob dies first. He leaves everything to Sue, so no estate taxes are due then. When Sue dies, her estate of $7 million uses her $3.5 million exemption. The tax bill on the remaining $3.5 million: $1,575,000!
But if, instead, Bob and Sue plan ahead, they can use both exemptions and pay no estate taxes. A tax-planning provision in their living trust splits their $7 million estate into two trusts of $3.5 million each. When Bob dies, his trust uses his $3.5 million exemption. When Sue dies, her trust uses her $3.5 million exemption. This reduces their taxable estate to $0, so the full $7 million can go to their loved ones.
This planning can also be done in a will, but you would not avoid probate or enjoy the other benefits of a living trust.

Buy Life Insurance

Depending on your age and health, buying life insurance can be an inexpensive way to replace an asset given to charity and/or to pay any remaining estate taxes. The three-year rule mentioned earlier does not apply to new policies. But you should not be the owner of the policy - that would increase your taxable estate and estate taxes. To keep the death benefits out of your estate, set up an ILIT and have the trustee purchase the policy for you.

Irrevocable Life Insurance Trust (ILIT)

An easy way to remove life insurance from your estate is to make an ILIT the owner of the policies. As long as you live three years after the transfer of an existing policy, the death benefits will not be included in your estate.
Usually the ILIT is also the beneficiary of the policy, giving you the option of keeping the proceeds in the trust for years, with periodic distributions to your spouse, children and grandchildren. Proceeds kept in the trust are protected from irresponsible spending and creditors, even spouses.

Remove Assets From Your Estate

A great way to reduce estate taxes is to reduce the size of your estate before you die. So, spend some and enjoy it!
Also, you probably know whom you want to have your assets after you die. If you can afford it, why not give them some assets now and save estate taxes? It can be very satisfying to see the results of your gifts--something you can't do if you keep everything until you die. Appreciating assets are usually best to give, because the asset and future appreciation will be out of your estate.
Assets you give away keep your cost basis (what you paid), so the recipients may have to pay capital gains tax when they sell. But the top capital gains rate is only 15% (assets held at least 12 months). That's a lot less than estate taxes (45%) if you keep the assets until you die.
Some of the most commonly-used strategies to remove assets from estates are explained below. Note that these are all irrevocable, so you can't change your mind later.

Tax-Free Gifts

This is easy and it doesn't cost anything. Each year, you can give up to $13,000 ($26,000 if married) to as many people as you wish. So if you give $13,000 to each of your two children and five grandchildren, you will reduce your estate by $91,000 (7 x $13,000) a year-$182,000 if your spouse joins you. (This amount is tied to inflation and may increase every few years.)
If you give more than this, the excess will be considered a taxable gift and will be applied to your $1 million gift tax exemption.
Charitable gifts are unlimited. So are gifts for tuition and medical expenses if you give directly to the institution.

Family Limited Partnership (FLP) and Limited Liability Company (LLC)

FLPs and LLCs let you reduce estate taxes by transferring assets like a family business, farm, real estate or stocks to your children now, and still keep some control. They can also protect the assets from future lawsuits and creditors.
Here's how it works. You and your spouse can set up an FLP or LLC and transfer assets to it. In exchange, you receive ownership interests. Though you have a fiduciary obligation to other owners, you control the FLP (as the general partner) or LLC (as manager). You can give ownership interests to your children, which removes value from your taxable estate. These interests cannot be sold or transferred without your approval, and because there is no market for these interests, their value is often discounted. This lets you transfer the underlying assets to your children at a reduced value, without losing control.

Qualified Personal Residence Trust (QPRT)

A QPRT lets you save estate taxes by removing your home (a substantial asset) from your estate now; yet you can continue to live there. Here's how it works.
You transfer your home to a trust for a period of time, usually 10 to 15 years. During this time, you continue to live in your home. When the time is up, it transfers to the trust beneficiaries, usually your children. If you wish to stay there longer, you may make arrangements to pay rent. If you die before the trust ends, your home will be included in your estate, just as it would without a QPRT.
There's more. A QPRT "leverages" your estate tax exemption. Since your children will not receive the house until the trust ends, its value as a gift is reduced. For example, if the current value of your home is $250,000 and you put it in a QPRT for 15 years, its value for tax purposes could be as little as $75,000. That leaves much more of your exemption for other assets.

Grantor Retained Annuity Trust (GRAT) and Grantor Retained Unitrust (GRUT)

These are much like a QPRT. The main difference is that a GRAT or GRUT lets you transfer an income-producing asset (stock, real estate, business) to a trust for a set number of years, removing it from your estate, and still receive the income. (If the income is a set amount, the trust is called a GRAT. If the income fluctuates, it's called a GRUT.)
When the trust ends, the asset will go to the beneficiaries of the trust. Since they will not receive it until then, the value of the gift is reduced. If you die before the trust ends, some or all of the asset may be in your estate.

Charitable Remainder Trust (CRT)

A CRT lets you convert a highly appreciated asset (like stocks or investment real estate) into a lifetime income without paying capital gains tax when the asset is sold. It also reduces your income and estate taxes, and lets you benefit a charity that has special meaning to you.
With a CRT, you transfer the asset to an irrevocable trust. This removes it from your estate. You also get an immediate charitable income tax deduction.
The trust then sells the asset at market value, paying no capital gains tax, and reinvests in income-producing assets. For the rest of your life, the trust pays you an income. Since the principal has not been reduced by capital gains tax, you can receive more income over your lifetime than if you had sold the asset yourself. After you die, the trust assets go to the charity you have chosen.

Charitable Lead Trust (CLT)

A CLT is just about the opposite of a CRT. You transfer an asset to the trust, which reduces the size of your estate and saves estate taxes. But instead of paying the income to you, the trust pays it to a charity for a set number of years or until you die. After the trust ends, the trust assets will go to your spouse, children or other beneficiaries.