I need to compile C project for Attiny85 but not sure which compiler to use - free if possible. Is Atmel Studio a good choice?
Free and the best compiler for AVR is AVR-GCC (in Windows it's called WinAVR).
It supports ATTiny85 (here is the list of supported devices).
So you just need to pass this option to compiler:
-mmcu=attiny85
You can look here for Makefile example.
To upload your firmware to ATTiny85 chip, you can use AVRDude program. It's free and most popular application for flashing AVR chips. See this for usage example.
As for IDE, there are plenty of them out there, but IMHO two best choices would be:
If you are novice, I'd say -- go with Eclipse.
For debugger I would recommend GDB. GDB is free and very powerful debugger software. It's easy to integrate GDB into Eclipse
Also you will need AVaRICE to connect GDB with JTAG.
All software I mentioned is free, cross-platform and actually being used for professional embedded development, so you can use it without second thoughts. Actually, it's almost single choice you have out there, except for IDE (still, my colleagues at work use mostly Vim and Eclipse, 50/50, so I think there is not much choice here as well).
Another good thing is that it's very easy to migrate to another MCU (from AVR) if you stick to software I listed above. E.g., for MSP430 there is similar GCC toolchain and similar flash software, and GDB of course. So you can just configure Eclipse to use msp430-gcc
instead of avr-gcc
and develop for MSP430.