I just downloaded the FLAC frontend, but I'm afraid I don't really know much about how it works. Under encoding options, it gives me the option to set the level to a minimum of 0 and a maximum of 8. I'm wondering how the level setting effects the sound quality of the resulting compressed file. Anyone care to help me out on this one?

The numbers correspond to the compression factor that FLAC goes through -- 0 is the fastest but offers the least compression (largest sizes) and 8 is the slowest and offers the most compression (smallest sizes). In comparison testing there is little difference between the default setting of 5 and the MAX of 8. Stick with 5 unless you have a rocket fast machine with hyper-threading.

There is no difference in output sound quality between 0 and 8 -- that is the benefit of using a lossless encoder. You will also not see any effect of the playback from a portable player between 0 and 8 FLACs.

Leave it on the default (usually 5). As mentioned by cmascatello, it's not a quality setting (like lossy), and will do nothing but save you possibly 1.5% of space... but can easily take 10X the time to do it.