OSX will run not very good at 233 Mhz with your current setup of only 256 MB RAM.
However Apple does say that the computer is OSX capable.
Anyway.
The best version of OSX, would be the latest one. Due to the fact that OSX runs better with a later version. I wouldn't buy Jaguar, that would be a waste. Wait for panther. it is said to be around 2.2X faster than Jaguar.
I would Put more RAM in there, 512 MB (maxed), and perhaps also take the Video RAM from 2MB to 6MB. (by adding 4), which will enable millions of colors.
you can get Video RAM and SDRAM from MemoryX, which I think is the best by far. The page for your iMac is
located here.With stats of:
G3 233Mhz
512MB RAM
6MB VRAM
your iMac should run quite well under X.