What is the best compressed iTunes format?

Apple AAC and apple lossless both use mpeg4 compression, apple lossless is simply compressed at a MUCH higher bit rate, and its variable compression. If you get into the specs, apple lossless has a bit rate of anywhere from 600kbps to 1100kbps, + or -, depending upon the track. AAC only goes up to 320kbps. AIFF is ripped at 1411kbps, which tells me that its a more true lossless format than apple lossless. I don't have any WAV files.
Your optical drive and the ripping software you use matters more than which file format you pick (AIFF, WAV, FLAC, etc.) when talking about bit-perfect rips.
I have Audio Tecnica earbuds, which are OK, not great, and I can hear the difference between a 320kbps rip into .mp3/AAC, and a 1411kbps rip into AIFF. More frequency extension and detail. I only rip AIFF and apple lossless, I avoid the lossy formats. Can I hear the difference between AIFF and apple lossless? Not really, not with the earbuds. If I went from my laptop through a DAC into my system, maybe. I recommend apple lossless, its a great middle ground. I don't want to listen to my favorite music at work knowing that I am missing something in the sound because the file format is clipping the waveform.

auto-converting to AAC when synching the iPod is a checkbox you can click in the iPod's properties when you connect to the computer. This produces 128 kbps files. IMHO this bit rate is too low and you will hear a decrease in quality compared to 320 kbps .mp3 or 320 kbps AAC. I don't recommend this low bit rate, 320 kbps files are not that much bigger in size. I rip the music I love to Apple Lossless, stuff I get from friends is .mp3 and I still have a ton of music in .mp3 format that I haven't re-ripped and probably won't. No, I cannot fit my entire collection on my iPod, but I have 30GB and that is plenty to keep me happy for weeks without deleting and re-loading. I recommend .mp3 over AAC because it is compatible with everything. For example, I cannot network my Denon 3310 AVR to play AAC files, only .mp3...
The shortcut for getting to import settings is pressing CNTRL and , at the same time on a PC. Then click the Import Settings button next to "Import CD" on the General tab.

Mezmo, great tip about converting formats, I didn't know iTunes did that. I am just about to purchase an Apple TV so I can stream Netflix, and this will probably lead to upgrading my entire library to AIFF so I can push it into my Denon 3310's Burr-Brown DACs. I doubt I will create double copies tho...I'll probably just run AIFF on my iPod and have fewer songs, at least at first... :-) All this ripping and re-ripping and converting is freakin' time consuming!

To each his own Mceljo, happy listening...!

All iPod's are not created equal. They use different DACs in different ones. The 5G, 30GB iPod video uses a Wofson DAC. The current models use a proprietary DAC that Apple developed themselves, I think. Its not Wolfson, I know that. There are also differences in power and cicuit design.
I have not done a test like this, but let me ask a few ?s:
Was your vinyl guy listening to the same song on both iPods?
Does this person have an iPod himself, is he used to having earbuds in?
The difference I hear between lossless and compressed iPod files is in the extreme frequencies - there is more detail in the low/high end with lossless files. Its something I had to listen for, and its more noticeable on some tracks than others. For example, the re-mix that Jimmy Page did on the entire Led Zepplin back catalog did not reveal more dynamic range in the recordings; this is not music I would recommend for a test like this. Tool is good. Electronica or IDM is good. Classical would work.
I have never A/B'd lossless vs. compressed in a blind test, then tried to ID the lossless rip. I will try to do this soon. I might surprise myself, and re-rip my entire library into 128 .mp3.
Eh...Probably not!
Also consider that Apple Lossless is not really lossless - it is a variable compression at a very high average bitrate, using a very efficient codec (MPEG4 I think). AIFF, WAV and FLAC are true lossless formats. Not sure if this would have made a difference in your test, but that was great to read about.

Magfan I am cornfused - if ALAC is lossless, why do I get different readings on different ALAC files for bitrate, when querying them in iTunes or in Windows Explorer? For example AIFF always shows 1411 kbps. But ALAC files are all over the place. Is this because the ALAC compression is variable, and I am getting an average reading, like I hypothesize above? Incidentally I did some research and yeah its lossless. The bitrates are winding me up.