A layer 3 switch makes packet switching (forwarding) decisions based on both layer 3 addressing as well as layer 2 packet switching (forwarding) decisions.

A very common mistake is that layer 3 switch functions are often compared with the functions of a router. A layer 3 switch is not a multi-port router. There are fundamental differences between the two:

Packet switching (forwarding) decisions

A router only makes decisions at layer 3, whereas a layer 3 switch makes them at both layer 2 and layer 3.

VTP (vLAN Trunking Protocol)

A router does not support this. It may have a NIC with 802.1q or ISL support, but only acts as an endpoint.

Interfaces

On a router they are seen as router interfaces, apart from creating bridge groups. A layer 3 switch routes packets between vLANs (and the vLANs are seen as router interfaces), the switchports are either 802.1q or ISL trunk ports, or belong to a particular vLAN (either statically assigned, or dynmically assigned using 802.1x).

Note that Cisco layer 3 switches like a Cisco Catalyst 3550 or 3750 series can be configured as multi-port routers, pure layer 3 switches, or hybrid router/layer 3 switches. When you get to Cisco Catalyst 4000 series and upwards, those switches are referred to as multi-layer switches, as they traditionally have separate routing and switching processors. These days, we are looking at each line card having its own switching processor (called dCEF (distributed Cisco Express Forwarding) modules in the Cisco world; aCEF (accelerated CEF) modules use the switching processor on the supervisor card).