In the this dialog you can set up ANSI colors. Usually, a MUD server is able to "paint" text, by adding ANSI commands to the text output. The client then sees these commands, and puts the appropriate color on the screen. ANSI commands are able to set up 8 background and 8 foreground colors, as well as a "light" mode. This results in 16 background, and 16 foreground colors.
This dialog allows you to set up all 16 colors. Some people (myself included) don't like light colors. For these people there is a "Use only dark colors" option. When you turn it ON JMC will use only 8 dark colors. Light colours will be mapped to a same dark color (it mean the ANSI light flag will be ignored).
See also: #highlight