The link that aureolin posted is exactly what you need. If you haven't already done so check it out. Key points are:

- your SQL Server service accounts should to be domain accounts, not LocalSystem.

- you MUST have your SPNs setup correctly for each server involved in the delegation chain.

- both the computer accounts and the SQL Server service accounts must be setup as Trusted for Delegation. This can either be constrained delegation if you're using 2003 native forest & domain, or full delegation for 2000 mode domain/forest.

In the past I've always found it much simpler to use fixed logins for linked servers. You shouldn't have very many logins you need to map from one server to the other so it's not that much of a management overhead - hopefully you don't have a company of users who all need access to the DB directly with their network logins?

Your LM authentication level should not affect this - you will either be using NTLM or Kerberos for Trusted Authentication, and the specific version of LM/NTLM doesn't matter. All of the above points are specific to only Kerberos anyway (unless you use protocol transition in a 2003 domain).

Regards,

Jacob