Reformating the C drive will not affect the D drive.
But, do you have a good reason to reformat the system drive? Reformatting is not necessary for an upgrade to either 98SE or XP. If you reformat, you will lose everything on that drive, and thus must reinstall all programs that are on that drive, as in the Program Files folder (unless you moved it to the D drive). If you don't reformat the drive, most programs and data should migrate automatically to the new OS.
While the upgrade should not affect any program files or data, things can sometimes go wrong; therefore, you should back up everything before installing the new OS.
You did not mention your processor speed. If it isn't at least 300 MHz, I wouldn't go to XP. We are operating some 360 MHz systems with XP Pro, and while a little slow, performance is generally astisfactory.
As far as 98SE is concerned, what does it have that plain 98 (with all upgrades), doesn't have and that you need? Would the upgrade be worth the cost and trouble?
If you do plan to upgrade to XP check out this PC World article on the subject:
I have my main C Drive (4gig) which I want to reformat from Win98 to Win98SE or maybe XP. My pc is 7 years old, a CompUSA model w/ a Pentium 2. It has 256 meg of RAM. Nonetheless, I have a supplemental 40 gig internal HD. My question is, if I reformat the C drive, will it do anything to my 40 gig of data on the supplemental drive? Also, once I reformat, will it automatically read the 40 gig HD?