This is a way of "discounting" the estate tax through the use of life insurance. Normally, life insurance death benefits are included in the Net Taxable Estate (IRC 2042).

The Irrevocable Life Insurance Trust (ILIT) is a method having one's life insured with a life insurance policy while not having the death benefits included in their Net Taxable Estate. These trusts were confirmed following the court case of Crummy vs. Commissioner, 397 F.2d 82 (9th Cir. 1968) as well as a number of following IRS Revenue Rulings.

Basically the ILIT is the owner of the policy. The insured person (or their spouse, etc.) makes annual gifts to the Trustee of the ILIT who purchases the policy and makes the periodic required premium payments. The Trustee must be a "disinterested third party" at "arm's length" and cannot be the insured, any family member, nor employee. Normally, the premiums gifted to the Trustee would be taxable under gift tax laws (the $10,000 exclusionary gift is not allowed where the asset is one of future value, such as life insurance). With a Crummey Power provison in the trust, the gifts are free of gift taxes up to $10,000 per year per beneficiary of the ILIT. If one had 3 beneficiaries, one could give, free of gift taxes, $30,000 per year for the Trustee to use for premiums. With each gift, the Trustee must notify the beneficiaries, in writing, that a gift has been made and that they have the right to intercept 5% or $5,000, whichever is greater, of this gift. If they fail to act within a specified period of time (usually 30 days), then the gift is retained by the Trustee to pay the policy premium.

The insured has no incidences of ownership over the policy. They cannot change beneficiaries, borrow against policy cash reserves, nor pledge the policy as collateral for a loan. The Trustee cannot be required to purchase life insurance with the gift. Nor can the beneficiaries be required to use the death benefits to retire the insured's estate taxes. These are "rules of agency" which can cause the ILIT to fail and the death benefits would be added to the insured's Net Taxable Estate.
There are two classes of beneficiaries. If the policy pays a death benefit on the death of the first spouse in a marriage, the Trustee can invest the death benefits and pay the surviving spouse (the income beneficiary) a pension for life. This would be taxable income for income tax purposes. The second class are the principal beneficiaries. Generally, this are the children who would receive the full death benefit at the death of the surviving parent.

An ILIT can be a very wise estate planning tool. For the expense of gifts to pay the premiums, the insured's estate does not have to pay a much larger tax at death. This, in effect, discounts the estate tax. Instead of having to pay a $1,000,000 estate tax obligation, the insured paid far less in gifts during their lifetime to pay the policy premiums. It is also an excellent vehicle for passing wealth to heirs, because the Trustee could monitor and limit how the wealth is distributed to them.
An existing life insurance policy can be irrevocably given to an ILIT, but the arrangement will not be recognized by the IRS for 3 years. This is the same generasl "look back" rule which is used for gifts in "view of imminent death." An ILIT must be registered with the IRS and have its own EIN number. The Trustee must submit an IRS SS-4 form and Form 56 along with a copy of the ILIT instrument to the IRS or the arrangement will not be recognized by them.