Your will instructs your executor to pay all taxes that are owing — local, state, and federal taxes. The most common taxes owing when a person dies are income taxes or estate and gift taxes. Chapter 17 covers your federal gift and estate tax exposure. (This book does not cover state gift or estate taxes, as each state has different rules governing these taxes. You should check with your state's taxing agency to learn what might be due at your death.)
Will my heirs have to pay any taxes on their inheritance?
It will depend on the asset being given to your heirs and what your will says. If your will directs heirs to pay a proportional share of taxes, their share of taxes will be paid before distribution. The executor is responsible for seeing that the estate taxes are paid before any distribution is made.
Your executor will be responsible for filing your final federal and state income tax returns. Most of the rules about how to compute the final income tax returns are the same whether you are living or it is your final return.
If your estate is required to file a federal estate tax return, there are elections to take certain deductions on the federal estate tax return versus your final income tax return. You should ask the accountant or lawyer who prepares the federal tax return about these elections.
If you leave a deferred account such as an IRA to your heir, she will have to pay income taxes on receipt of the funds. She will not owe estate taxes, however, on the value of the IRA, as taxes on that asset were paid by the executor prior to closing the estate.
If you choose to use a will as your planning document, the probate court will not allow your executor to close your estate until he has verified that all tax returns have been filed. In most cases, this means that your estate cannot be closed until after January 31 following the year of your death. This is because payers are not required to send tax statements (W-2s, 1099s, K-1s, other tax forms) that you need to complete the return until January 31. Also, the federal estate tax return, if one needs to be filed, is due no later than nine months after the date of your death. Preparing this return may delay final distributions and the closing of your estate.