Originally posted by BaLuX:

Flattening is always done at the height your character is, no matter where you aim. Whenever you are flattening, make sure that your character is standing on an already flattened part.

This is very true for building flat areas for foundations. However, here's another tip...

If you are looking to build roads, it's often times advantageous to flatten relative to your surroundings, and NOT relative to where your character is standing. For this, hold down the "CTRL" key (or maybe it was SHIFT, but I'm pretty sure it was CTRL) while flattening. The area will then be flattened relative to its surroundings and NOT relative to where your character is standing.

As I mentioned, this is a very nifty feature when trying to build roads and paths, especially if you plan on using carts.