In order to pass on your wealth to your chosen beneficiaries at death, in addition to probate and other estate settlement costs, you (or more correctly, your estate) may have to pay death taxes at the federal level, and possibly also at the state level.

Death taxes come in two main varieties: estate taxes and inheritance taxes. The federal government and the following twenty-four states currently have estate taxes which tax the estate before it is distributed: Connecticut, District of Columbia, Illinois, Indiana, Iowa, Kansas, Kentucky, Maryland, Massachusetts, Minnesota, Nebraska, New Jersey, New York, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, Tennessee, Utah, Vermont, Virginia, Washington and Wisconsin. The following eleven states impose an inheritance tax: Indiana, Iowa, Kansas, Kentucky, Louisiana, Maryland, Nebraska, New Jersey, Oregon, Pennsylvania, and Tennessee.

You should be aware that most of the states impose what is sometimes called a "pick-up" estate tax, the calculation of which is based on the federal taxable estate. Because the federal taxable estate is determined after a deduction for state death taxes paid, the two calculations are intertwined. Although there are variations in these "pick-up" taxes, it is generally designed so that the state tax is limited to an amount no larger than necessary to reduce federal estate tax to $0. So, if a person's federal taxable estate, prior to a deduction for state death tax, is at a level that doesn't result in a federal estate tax liability, then the person shouldn't have a liability under a state pick-up tax. In effect, the state pick-up tax takes an amount that would otherwise be paid for federal estate tax.

Federal estate tax. We will focus here on the federal estate tax because it is potentially applicable to you no matter where you live, while state tax liability can vary widely.

Actually, although there is a separate federal estate tax, tax liability is computed on the basis of what is called the federal unified transfer tax. The unified transfer tax is made up of three distinct, but closely related, taxes:

• the estate tax,
• the gift tax and
• the generation skipping transfer (GST) tax.

Both the federal gift tax and the GST tax have their own sets of rules and planning strategies, but for purposes of this discussion, we'll only briefly introduce them and point out their main purpose: to prevent avoidance of the estate tax. Without the gift and GST taxes, individuals — particularly wealthy individuals — could get out of paying the estate tax by making lifetime transfers.

The unified transfer tax is computed with reference to the value of the property that is considered to be in your gross estate at death, plus the value of taxable gifts that you made during your life. Generally, if the total of your lifetime taxable gifts and the value of the property that you own as of the date of your death exceeds $5 million for decedents dying after 2009, but before 2013, a estate tax liability may be owed on the excess value. The estate tax rates through 2012 range from 18 percent to 35 percent--the estate tax is once again up for grabs at the end of 2012.

The estate tax had expired at the end of 2009. Congressional action revived it retroactively for 2010. However, estates of decedents dying in 2010 can elect not to be subject to the estate tax and to have the prior carryover basis rules apply. Under these rules, the decedent's basis carried over to the recipients of the property.

However, if your gross estate exceeds the limit for exclusion from estate tax, all is not lost! There are many deductions and strategies available to reduce or eliminate the estate tax liability. Here's what you need to consider:

• the marital deduction
• the charitable deduction
• credit shelter bequests
• lifetime gifts
• trusts
• life insurance
• powers of appointment
• the special use valuation
• deferred payment of estate tax
• alternate valuation date
• generation-skipping transfer tax