If you want internet access on both machines, but WITHOUT the main machine powered up, you need a router.
You should buy a router that has a built in modem and firewall as a minimum. This plugs into your telephone line, and each computer connects to the router. Likewise, if you want to go to a wireless solution, you still need a wireless router, but be aware, wireless networks bring their own challenges, not least of which is security, and are never as fast as a conventional network.
If you are content to have your "internet" computer on whilst using the internet, the solution is considerably cheaper. The cheapest option would be, two network cards and a crossover cable.
There is no reason to up-grade to XP on the main PC. Win98se is adequate.