In the opening scene, an attractive blond woman wearing a lavender colored dress is making out with a man in a local cemetery, which suddenly ends when the woman pulls out a dagger and stabs the man to death.
Meanwhile, 24-year-old musician Jody Pearson is raising his 13-year-old brother Mike in a small southern California town disturbed by the mysterious deaths of its citizens. Reggie, a family man and ice cream vendor, joins the brothers in their suspicions that the local mortician, dubbed "The Tall Man", is responsible for the deaths.
Mike relays his fears to a fortuneteller and her granddaughter about the possibility of Jody departing and leaving him in the care of his aunt, along with his suspicions about The Tall Man. Mike is shown a small black box and told to put his hand into it. After the box grips his hand, Mike is told by the granddaughter not to be afraid and as the panic subsides, the box relaxes its grip. The notion of fear itself as the killer is established and is what propels Mike towards his final confrontation in the film with The Tall Man.
Fearing that Jody will abandon him, Mike follows him one evening to a local bar where he sees him pick up the woman in lavender from the opening scene and follows them to the Morningside Cemetery where Jody and the woman make out with each other. Just then, Mike is scared from his hiding place when a small figure wearing a brown robe jumps out at him. Jody, alerted by Mike's scream, finds him and angrily tells him to go home. When Jody returns to the make out spot, the mysterious woman in lavender is also gone.
Mike begins to have horrifying nightmares about the Tall Man and of his dwarf-like minions and determines that something is going on at Morningside Mortuary. After an encounter when he is pinned under a car when one of the dwarfs drops a car on him while he is working in the garage, Mike decides to investigate.
The next evening, he goes out, armed with a hunting knife, to Morningside Mortuary and breaks into the building through a basement window. Mike hides when the Tall Man and the cemetery caretaker are seen. Walking down a long hallway at the mortuary, Mike encounters a flying silver sphere, about the size of a softball, coming right at him. The caretaker appears and grabs Mike as the flying sphere comes right at him. Mike ducks in time as the sphere hits the caretaker and drills into his head, spurting out blood. Mike then encounters the Tall Man who chases him to the basement where Mike manages to sever some of the fingers of the Tall Man's right hand. Mike escapes from the mortuary and from two of the Tall Man's brown-robed dwarf minions and runs for home.
The next morning, Mike shows Jody the severed finger of the Tall Man which is still twitching with life and bleeding yellow embalming fluid, which Mike is keeping in a small box. When Reggie comes over, and Mike shows them the severed finger, it transforms into a large wasp-like insect which attacks the three of them, but Jody manages to kill it by shoving it into the kitchen garbage disposal.
The next evening, Jody goes to Morningside Mortuary to investigate, armed with a .45 caliber pistol, but he is immediately attacked by one of the brown-robed dwarfs in the mortuary basement, forcing him to run. Jody runs into Mike outside the cemetery driving their car when they are chased by a hearse being driven by one of the dwarfs. Jody opens fire on the hearse with his shotgun and forces it off the road. Upon examining the dwarf driver, the two brothers are shocked to find that it is a former friend of theirs (murdered by the woman in lavender in the opening scene) now crushed down to small size.
Jody and Mike call Reggie who takes the still alive body of their friend into Reggie's ice cream truck while Jody drops Mike off at a local antique store. There, Mike finds an old photo of the Tall Man in an 19th Century photo during the founding of the town. Mike asks the two young store workers, Sally and Sue, to drive him home. During the drive, Mike tells them to stop the car when they see Reggie's overturned ice cream truck lying beside the road. Mike looks around and finds that the creature dwarf has escaped and Reggie is nowhere to be found. Just then, a group of dwarfs attack Mike and the girls who take control of their car and drives away, while Mike falls out the rear window.
Mike goes home and tells Jody about Reggie's disappearance and about the recent attack. Jody decides to go back to the mortuary to look for Reggie and the two girls, and Mike wants to come along. But Jody instead locks him in his room, feeling that it would be too dangerous. Mike, using a buckshot shell, manages to disable the lock on his door and takes a pistol from the house to meet up with Jody, but the Tall Man is waiting for him outside (with his hand fully healed) and forcibly takes Mike into his waiting hearse to drive back to the cemetery. Mike manages to shoot out a tire from the car as it arrives at the mortuary which goes out of control. Mike manages to jump out of the car before it hits a tree and explodes, with the Tall Man still inside.
Inside the mortuary, Jody is breaking into a crypt of his parents to find if their bodies are still there. Mike enters the building minutes later and sees his parents unearthed coffins and upon opening one, and finds that they are empty. Mike runs and has another encounter with the lethal flying silver sphere, until Jody shows up and destroys the silver sphere with a blast from his shotgun. The two brothers then encounter Reggie, who claims that he made it to the mortuary and has been hiding in a coffin for the past few hours. Reggie also claims to have found the missing girls in a room and freed them.
Mike, Jody, and Reggie then go into another room which is a large open area, filled with storage barrels containing several dwarfs, as well as two long poles which upon close examination, is the gateway to an alien planet. Mike is briefly sucked through, but saved by Jody and Reggie who pull him back. Mike realizes that the Tall Man is using the corpses as slaves to his alien planet, and they have to be crushed to small size because of the planet's intense gravity and heat. When the lights in the building go off, Mike disappears and Jody sets off to find him.
Alone in the small room, Reggie decides on a gamble to shut down the humming two-pronged gateway by slamming his hands on the tops of the poles, creating a vacuum which he barely escapes. Outside the mortuary, Reggie encounters the woman in lavender, who stabs him to death with the dagger. Mike and Jody come upon the scene and discover the woman in lavender, who changes into the Tall Man, yet another replica. Mike and Jody are forced to run as the mortuary glows and is apparently destroyed.
Back home, Mike and Jody, distraught over the death of Reggie, and that the entire town is either dead or consumed by the gateway vacuum, plot on a way to stop the Tall Man by trapping him in a mine shaft since there seems to be no way of killing him. While Jody sneaks out of the house to go to a remote area near a mine shaft to prepare the trap, the Tall Man arrives at the house and attacks Mike who is forced to run. The chase leads to the mine where the Tall Man falls through a fake ground into the hole and to the bottom where Joey pushes a large boulder to seal the hole, thus trapping the Tall Man.
After doing so successfully, Mike suddenly wakes up with a start in his house. Mike is next seen lying by the fireplace with the alive-and-well Reggie sitting next to him.
Reggie tells Mike he was simply having a bad dream, something that has been a common occurrence since Jody died in a car crash a few weeks earlier. Mike realizes that Jody is indeed dead as well as his parents... all of whom died in the car accident, and the whole thing with the Tall Man was nothing but his horrible nightmare. Reggie suggests that they go away for a while, and Mike agrees.
Mike goes into his room to pack his stuff where the Tall Man is waiting for him behind his door. After Mike is shocked to see the Tall Man behind his door, several arms of the dwarf minions pulls Mike through his bedroom window as he screams....