Using FAT32 for your WinXP partition is fine, you just lose out on features like encryption, file level security etc, which is enjoyed when using NTFS.
The drive which you are planning to split up can have more than one FS, once partitioned think of the one drive as however many seperate drives. Also take in to consideration that Linux will need 3 partitions really - /boot /root /swap. These partitions will not have drive letters as Windows uses 'C:', the drives are addressed via there device name like hda1, hda2...
The data partition which you plan to create should be fomatted using FAT, the reason being that both WinXP and Linux will be able to read and write to the partition.