Of course, when your HEIRS receive their INHERITANCE, said inheritance will be taxed as income. Depending on which state you live in (as an heir), you may also be taxed federally AND by your state, but the amount of tax you pay (as an heir) depends on your relationship to the estate.
While I am not an expert on estate tax I have studied income tax law for over 10 years. Actually as an heir, you generally don't pay income tax on any inherited property. You only pay tax on any income that property produced after you inherited it. For example, if grandma dies and leaves you a house worth 250,000 you don't include 250,000 of additional income on your income tax return. Now if you sell the house six months later for 300,000 you must include that 50,000 profit as income (capital gain, actually).
My understanding of federal estate tax is that the corpus of the decedent's estate is taxed, after certain deductions. The tax is to the estate, not the heirs. This is done on Form 706. Heath, there is no federal inheritance tax as you've described as far as I'm aware. Do you have a form number you could point to? Now, if the estate has income after the owner dies but before the property is dispersed to the heirs, the estate may have to file a tax return (Form 1041) reporting that income.
[This message has been edited by Wendy Wilson (9/29/2009)]