I've only got a Shuffle, so I'm not sure of the specifics for other iPods, but typically the difference between line-out and headphone jacks is the volume levels and processing. So, connecting a device from line-out to line-in, the volume levels are standardized, so adjusting the volume on the iPod won't affect the volume of the music you're playing. Similarly, EQ settings on the device usually don't affect line-out audio, so if you've got the bass boosted on your iPod, it won't affect the bass levels of the sound coming out of the line-out. Connected through the headphone jack, volume and EQ levels will affect the sound you hear.
If you're connecting from the headphone jack to a line-in connector, weird things can happen with EQ and volume settings. If, for example, you've got the bass boosted on your iPod and on your stereo, it will effectively be boosted twice. This can make things sound terrible, and similarly it can be a bit tricky to get the volume levels right, since, for example, a low output volume with a high stereo volume may play at the same level as a high input volume and low stereo volume, but one will have less noise.
I suppose the iPod jack works like a line-out (as was suggested above), but I'm not sure about this.
