Choosing an external dac and type of connection will depend on your tastes, budget, etc. More and more 'audiophile'-grade USB dacs are showing up (Wavelength, UltraFi, Scott Nixon, Empirical, Red Wine, etc). Firewire is typically used with pro gear (M-Audio etc). And, as mentioned above, a cost-effective solution would be to use your current dac (if you have one) with a USB-SPDIF converter (Hagerman, Trends, etc), or via ethernet or wifi (AEx, Squeezebox, etc).
Regarding settings, as long as you are listening to 16/44.1 there are no additional tweaks required. If you plan on listening to higher resolution files (and your dac supports it) you'll have to set the higher bit and sample rates in AudioMidi so that they are passed untouched from iTunes.