If a sole proprietor converts their business to an S Corporation, how is their Income Taxed?

1) Compensation for services is taxed as wages reported on Form W-2. The owner's share of the business profit is reported on Schedule K-1 and taxed as ordinary income.

2) Compensation for services is reported on Schedule K-1 and subject to ordinary income tax and self employment tax.

3) All Income from the business is reported on Schedule C (Form 1040) and is subject to ordinary income tax and self-employment tax.

4) All income from the business is taxed to the business. The business owner pays no income tax or self-empoyment tax.