(FORTUNE Small Business) – Mixing religion and business is getting more complicated as it grows more common, particularly for company owners. Consider Christopher Miller of ATSI, a computer networking firm in Athens, Ala., and his employee Darla Tillery. Miller repeatedly lectured Tillery about her allegedly sinful life. On one of her annual reviews he wrote, "Keep going to church, seek God first." When Miller fired Tillery, she sued ATSI for religious discrimination. Tillery lost, but the judge in the 2003 case noted that Miller's behavior "could be deemed objectively offensive by a reasonable jury."

U.S. courts normally try to balance the employer's right to express his values through his business and the right of employees not to feel discriminated against. Business owners are also free to express their faith in advertising and marketing materials, as long as they are not exclusionary. In a landmark 1984 case, a Jewish businessman filed a suit against a Christian yellow-pages phone directory based in Modesto, Calif., because the directory had refused to publish his listing. An appellate panel upheld the company's right to publish Christian-business directories but ruled that it could not exclude non-Christian advertisers.

Civil rights legislation bars employers from making any employment decision based on religion, but it covers only firms with 15 or more employees. Smaller companies are free to use religion as a reason to hire, fire, or promote an employee--as long as they're not located in a state whose laws cover smaller businesses. Laws in many states, such as Florida and Maryland, mimic federal law with a 15-person threshold. But in New Jersey and Oregon, for example, antidiscrimination rules apply even if you have only one employee. Smart business owners know the law and find ways to make employees of all faiths--or none--feel welcome at their companies. Here's how:

HIRING Most business owners know better than to discuss religion in job interviews. Above the federal threshold of 15 employees, or smaller state thresholds, only religious organizations can legally use faith as a condition or factor in hiring. In the case of EEOC v. Townley Engineering & Manufacturing Co. (1988), an employee of the Candler, Fla., firm claimed he was fired for refusing to attend workplace devotional services. The courts rejected Townley's argument that it should be treated as a religious organization because the owners were "unable to separate God from any portion of their daily lives."

PRAYER AT WORK Entrepreneurs are free to conduct prayer meetings or other faith-based activities but can't make them a factor in employment decisions and should offer workers of other faiths the opportunity to hold their own meetings. Michael Maslanka, an attorney who represents small and large companies at Dallas law firm Ford & Harrison, says prayer meetings should be held before or after work. "Don't make it part of the workday," he advises. "That's just too much pressure on employees who don't share your beliefs." Thoughtful Christian employers are careful about how they treat prayer at training sessions and other mandatory work activities. If they choose to preface a business meeting with a prayer, they make it clear that employees can abstain.

PROSELYTIZING Smart business owners refrain from insulting someone else's beliefs while propounding their own. Over the course of two years, Ray Chester, the owner of Universal Traffic Service, a freight broker in Grand Rapids, asked all his employees to sign a written "corporate prayer." When one worker began medical treatment to battle colon cancer, Chester told another employee he wished to convince the sick staffer that praying would be more effective. Informed that his actions were illegal, Chester said that UTS was his company and that he could do what he wanted, according to legal documents. Two employees quit in 1999 and sued UTS for religious discrimination. In 2003 the court found in favor of both employees' claims that religious conduct created a hostile work environment and awarded each more than $375,000.