When you connect your phone, Reserved Space is explained, with examples, under Settings/Phone/Reserved Space.
Basically, you're setting how much space should not be taken up by/be available for your ordinary content typically stored in "files" and listed in Zune. I read this reserved space as an Other category to include non-file data such as mail and data generated by apps. I also suspect it's space available to apps for whatever they do that is known to you or not. I reserve one percent of my 36.9 GB install, or .369 GB, which appears to be the lowest non-zero setting allowed.