The first thing to do is to determine your goals.  Do you want to reward a few valuable employees for past service?  Provide an incentive for employees to grow the business' value?  Prepare an exit strategy for yourself?  Achieve tax savings?  Some or all of these goals can be realized, but depending on which are more important to you, certain approaches will be preferable to others.  Your business structure (corporation versus LLC or partnership; many employees versus few, etc.) also will play a role.

The simplest thing to do is simply sell your employee a portion of the business at its fair market value.  (Transfers below market value generally are treated by the IRS as taxable compensation to the employee in the amount of the discount.)  The sale can be done by current owners selling a portion of their interest in the company, or the company issuing new shares or interests.  Either way, the current owners will own a smaller percentage of the company, but in the first case, the selling owners likely will realize taxable gain, while in the second, there may not be a taxable event to any of the parties involved.

If a more incremental approach to ownership is desired, stock options and Employee Stock Purchase Plans (ESPPs) may be appropriate.  Straight stock options, the right to buy employer stock at a predetermined price in the future, tend to be more compensation-oriented.  ESPPs, while technically a type of stock option plan, may be more effective at encouraging long-term employee ownership.  A typical ESPP will allow employees to accumulate stock over time through payroll deductions with periodic purchases.  Either alternative permits (but does not require) selling stock to employees at a discount with tax advantages to the employees if certain tax rules are met. 

A more involved choice is an Employee Stock Ownership Plan.  An ESOP is a type of tax-preferred qualified retirement plan.  It can provide significant tax benefits to employees, the company, and to the selling shareholder if various requirements are met.  Set up and administration can be complex, but the tax savings can be great.

There are other alternatives but regardless of the method chosen, there will be many legal and tax details to address.  For example, will employees be given management rights, or only economic rights?  How will you address subsequent transfer issues--to whom, if anyone, can the employee sell, gift or bequeath stock?  Upon the employee's termination or death, will the company have a call right to repurchase the shares?  By considering these issues up front, you and your business advisors can design an arrangement that best meets your needs.