What?
In most people's imagination, a chalk outline specifically refers to an outline of a murder victim's body, supposedly drawn by the police to aid future investigators after the corpse itself has been taken away to be examined. Although usually referred to as being drawn with chalk, the outline is often in fact paint or tape.
Was it actually ever done?
Commonly, when asked whether or not chalk outlines are ever drawn, police will either reply that it was never actually done, that it was just TV, or that it is not done any more. The reason usually given is that it could contaminate the crime scene by disturbing "trace evidence" - hair, blood specks, even sweat. In order to remember how it looked, the body is photographed and great care is taken not to move any significant objects around or from the scene.
This does not mean there has never been an instance of it. Newspaper photographs of crime scenes from the interwar period in America sometimes show chalk outlines. The rational here was that showing the actual body would be tasteless and obscene and so an outline would be drawn for the press' benefit once the investigation had been concluded. Nowadays, with a less shockable public and far greater importance placed on forensic evidence, the practice has largely died out. Exceptions may occur when an inexperienced police officer deals with a homicide and draws an outline; these officers have been referred to as "chalk fairies" since they rarely identify themselves.
The only time when an outline may officially be drawn is when the body has to be removed quickly, possibly because the victim is still alive and requires urgent medical attention. Road accidents have been cited as cases where this may occur, especially since the cause of injury is usually known and it is unlikely that the medium used to draw the outline will seriously contaminate the scene in any meaningful way.
Whilst not strictly an outline, police will sometimes mark the position of the victim's head with a small spot or cross, so as to leave as little contamination as possible.
Media
As with many urban legends, the media is largely responsible for the myth that police draw chalk outlines around murder victims. The reason for this is two-fold: firstly many networks will restrict the hours in which programmes that show dead bodies can be broadcast and so for a reasonably gentle murder-mystery or legal drama designed to be broadcast as daytime TV, chalk outlines provide a convenient alternative to showing the actual corpse. Secondly, there are dramatic reasons for not showing bodies, where for instance the identity of the murder victim needs to be kept a secret, or where the mode of death will become important later on, or simply because it's what audiences expect to find at a crime scene after the body has been removed. Wikipedia notes (though does not provide a source) that the US legal drama Perry Mason was the first television programme to use white outlines to indicate homicide victims.
The computer game Gangsters (1998), published by Eidos Interactive, made use of the chalk outlines to show where gangsters had died. This method provided a justification for the bodies fading away and enabled large numbers of deaths to take place on one spot without a pile of corpses mounting up absurdly.
Other Uses
The most common alternative use of the chalk outline is as a mild practical joke. Often performed in changing rooms (where there are unlikely to be cameras or staff), the prankster will draw a rough outline of a body, possibly including some red marks on the floor as faux blood stains. For a more realistic affect, the area may be cordoned off with police tape.
For A Quest in Honour of Jessica Pierce
Sources
http://forums.officer.com/forums/archive/index.php/t-16856.html
http://msgboard.snopes.com/cgi-bin/ultimatebb.cgi?ubb=get_topic;f=92;t=001770;p=1
http://www.straightdope.com/columns/010413.html
http://en.wikipedia.org/wiki/Perry_Mason | 
