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 there can be problems when the second spouse dies.

For example, let’s say Bob and Sue have a combined net estate of $10 million and they both die when the federal exemption is $5 million. When Bob dies, he leaves everything to Sue, so no estate taxes are due then. But when Sue dies, her estate of $10 million uses her $5 million exemption. The tax bill on the remaining $5 million? $1,750,000!

Congress tried to fix this. Under current law, if Bob dies before Sue, his unused exemption can be transfered to Sue. But if Sue remarries and outlives her new husband, she would lose Bob’s unused exemption. Also, by leaving everything to Sue, Bob has no control over how his share of the assets are managed or distributed. Plus, any growth on the assets will be included in Sue’s estate and taxed when she dies.

If Bob and Sue plan ahead, they can use both exemptions and solve these problems. A tax-planning provision in their living trust splits their $10 million estate into two trusts of $5 million each. When Bob dies, his trust uses his $5 million exemption. When Sue dies, her trust uses her $5 million exemption. This reduces their taxable estate to $0, so the full $10 million can go to their loved ones.

In addition, Bob can keep control over how his share of the estate is managed and distributed; the assets are valued and taxed only at his death, so no growth is included in Sue’s estate; yet, the assets in Bob’s trust can be available for anything Sue needs. Married couples with estates of all sizes find these benefits appealing. (This planning can also be done in a will, but you would not avoid probate or enjoy the other benefits of a living trust.)

In the simplest terms, there are three ways:

1. If you are married, use both estate tax exemptions.
2. Remove assets from your estate before you die.
3. Buy life insurance to replace assets given to charity and/or pay any remaining estate taxes.

To determine the current net value, add your assets, then subtract your debts. Include your home, business interests, bank accounts, investments, personal property, IRAs, retirement plans and death benefits from your life insurance.

Your estate will have to pay federal estate taxes if its net value when you die is more than the exempt amount set by Congress at that time. In 2019, the federal exemption is $11.4 million and the highest estate tax rate is 40%.  Some states have their own death or inheritance tax, so your estate could be exempt from federal tax and still have to pay state tax.

Estate taxes are different from and in addition to probate expenses, which can be avoided with a revocable living trust, and final income taxes, which must be paid on income you receive in the year you die.

Federal estate taxes are expensive (historically, 45%-55%) and they must be paid in cash, usually within nine months after you die. Because few estates have the cash, it has often been necessary to liquidate assets to pay these taxes. But, if you plan ahead, you can reduce and even eliminate estate taxes.