We generally recommend recording to WAV format as this provides the best audio fidelity and makes VinylStudio run faster. If you are short of disk space however, you might like to record to MP3 format. This uses much less disk space - about 75MB per album rather than 500 - but there is a slight loss of sound quality. All VinylStudio functions are available on either type of file, and there are also facilities to convert from one format to the other. To help you decide, you might like to make a couple of test recordings and compare them on headphones.
If you plan to cleanup your recordings, recording to WAV format is recommended as declicking is faster, and generally works better, on these files. You should also record to WAV format if you intend to edit your recordings in another program (such as Audacity, CoolEdit or Adobe Audition).
The recording format VinylStudio uses is set in the Recording Options dialog under the Options menu.