I spent a little while looking at this so I thought I'd share my findings....
Currently, if you want to write an application that runs on .net 1.1, then you have to use Visual Studio 2003. Equally, if you want to write an application that uses .net 2.0 then you have to use Visual Studio 2005.
For the SharePointers out there, this generally means that you'll have to stick with Visual Studio 2003 unless your admins are happy with you installing .net 2.0 on the SharePoint servers.
There is one saving grace here and that is that you can install Visual Studio 2003 and Visual Studio 2005 on the same machine. So if you are like me and need to do both, you can do.
Also, Microsoft are thinking (not confirmed) about providng a plug-in to Visual Studio 2005 that fills the gap, you can read more here: http://blogs.msdn.com/clichten/archive/2005/10/05/477506.aspx.
Usefull related links:
WSS 2003 .net 2.0 code snippets: http://weblogs.asp.net/jan/archive/2006/02/01/437037.aspx
Explanation fo .net 2.0 support for SPS and WSS: http://blogs.msdn.com/mikefitz/archive/2005/09/12/464273.aspx
Hope this helps