In my experience its very compatible.
Win 95/98/Me relied on a core of DOS, mainly for compatibility reasons. NT/2000 relied on a new non DOS kernel which was more robust. NT/2000 uses an emulator for DOS sessions and but it doesn't always work.
XP combines the two - its based on the NT/2000 kernel, so 32 bit Windows apps that work in NT/2000 today will likely run without any issues. It also has much improved ability to handle old DOS based and/or 16 bit Windows apps.
So if anything, its compatible with more things than any other OS.
In practise, I migrated to XP from 98 and haven't found any problems. My CD burning software didn't work - but its built into the software for XP already, so I'm not missing anything.
James