I know that this sounds like a LMGTFY question but i thought i'd ask it so that google actually turns up (more) good results. What is it?
A kernel panic takes place when an Operating System detects a fatal error that it cannot recover from. This is a term specific to UNIX and UNIX-like Operating Systems (Linux, OSX, etc). The Windows term is a "STOP Error", and the OS will make a memory crash dump and write to the system log files, you may even get the well known "Blue screen of death".
The wikipedia article covers it better than I can: http://en.wikipedia.org/wiki/Kernel_panic
It's the Linux (and UNIX) equivalent of the infamous BSoD (Blue Screen of Death).
From wikipedia's Kernel Panic page:
A kernel panic is an action taken by an operating system upon detecting an internal fatal error from which it cannot safely recover. The term is largely specific to Unix and Unix-like systems; for Microsoft Windows operating systems the equivalent term is ‘Stop error’ (or, colloquially, ‘Blue Screen of Death’).