What do you imagine when you hear
"What's that?"
vs.
"What is it?"
It depends on what you want to stress on.
In case of "What is it?" - it is the "IS" that is getting stressed.
But in case of "What's that? " it is the "THAT" that is getting stressed.
Probably you understood that mild difference.
"It" is a subjective pronoun. "That" is a demonstrative. There is a difference. In general use, something like "What is that!" would be used when there isn't a clear object. For example, if I was looking at a flock of birds and one of them was different, I would say "Look at that!" or "Look at that bird". But if we were talking about said bird, I might say "I wonder what kind of bird it is." I hope this clarifies something, if at least the usage.