Yes, you can use the upgrade path. In 98, just put in w2k CD, select install w2k, and select upgrade. Upgrade is supposed to keep programs and data intact.
Whether you want to upgrade is another question. A clean install is recommended as you have a cleaner start.
Either way, as Diodorus says, you may still have to download drivers and related software for certain hardware (such as printer, scanner, modem if you use one). Modem is particularly tricky as Windows (whatever version) hardly ever finds the right modem driver from its archives.
If you want a clean install, remember to format partition, and use if possible NTFS file system.
Yes, you can install w2k on fat32. If you're upgrading, you shouldn't be asked to format. If asked, say leave existing file system intact.
If you tell w2k to install a new copy or fresh copy, you will be asked, just like XP. You should be then given a choice of NTFS, FAT or leave file system intact.
If you're installing fresh copy and want to retain FAT32, you should still choose format with FAT (otherwise existing stuff on partition will still be around, and if the partition itself has an old OS on, you might get a half-baked dual boot which you don't want).
If your existing partition is FAT32 but larger than 32GB, then you won't get a choice to format with NTFS, because w2k's FAT32 formatting program cannot format a FAT32 partition larger than 32GB.
Otherwise if there are no other constraints, choose NTFS rather than FAT32.