In no particular order:

Bebot
This app is truly made for a touch screen device. No other app gives you as much expressive control as Bebot. Plus it's cute.

NLog Synth
My pick for the best sounding analog synth on the iPhone.

bleep!BOX
Amazing new app. Super tweak-able sounds, great looping/stutter effects in "performance mode", great looking UI.

BeatMaker
Without a doubt, the best drum machine/pad based sample player available for the iPhone.

Star Melody
Super simple/beautiful UI and great sounds. I have created many melodies/song ideas on this app.

Sound Scope Space
Trip out and scare your pets all with one simple app. The "KUZMOSCILLATOR" is my favorite. Plus draw your own waves... It's like an Asian Horror movie soundtrack creator.

Xewton Music Studio
It's like GarageBand on the iPhone... right down to the over dramatically lit, super detailed instrument illustrations. This app has just about everything an entry level DAW should have. ON YOUR PHONE! Unbelievable!

JR Hexatone Pro
Thinking way outside the box on this one, Amidio has changed the game for iPhone music creation apps. This thing is endless...

iTouchMidi (iTM) Series: iTM Keys, iTM Matrix, iTM Pad, iTM Tilt, iTM MCU, iTM Dj
Midi control made easy. Download the iPhone app and the desktop app, run, connect, assign controls, done.

TouchOSC
Midi control made hardcore: Not quite as easy to get running as the iTM series but so much more power. And with the latest release of TouchOSC Editor you can create custom layouts on your laptop/desktop and upload them to your iPhone. Limitless.....