Under current tax law (2011 & 2012, subject to change after 2012) most of you will not pay a death tax (called an estate tax). Yet I see so much political propaganda and misleading media editorials on the death tax saying otherwise. Ignore it; most of you will not be subject to a death tax and here is why.
Federal Level Death Tax
Here is why most of you will not pay a death tax. Each person can pass along up to $5 million in assets (investments, real estate, collectibles; essentially everything you own) and your estate or heirs will pay no death tax. That means if you are married, between you and your spouse you can pass along $10 million of assets and your estate will pay no federal death tax.
Income Taxes May Apply To Heirs On Select Assets
In general, your heirs do not pay income tax on assets they inherit, unless it was a tax deferred asset such as an IRA, 401k or other qualified retirement account. Although no death tax is payable on these assets (unless your total estate exceeds the $5 million amount) since the assets inside qualified retirement accounts have not yet been subject to income tax, as your heirs withdraw those assets they will pay income tax at their applicable tax rate in the year they take the withdrawal.
State Level Death Tax
Your estate may be subject to a state level death tax, although currently only a handful of states impose such a tax; state laws vary so you must check for any applicable death tax in your state of residence to determine if a state-level tax would apply. See State Estate Tax for a state-by-state list.
If No Death Tax, Why Do Estate Planning?
Most Americans do not have estates large enough to be subject to a federal level death tax. This means your estate plan does not need to focus on tax avoidance. It needs to focus on making sure you have named the proper people to make decisions for you when you are not able, and making sure your accounts are titled correctly and your beneficiary designations set up properly so your assets avoid the probate process while going to the people you want them to go to.