Non-Qualified Stock Options (NSO's)
Non-Qualified stock options are more common than incentive stock options (ISO's), but also more straightforward. NSO's give you the right to purchase company stock at a stated price (the strike price). When exercising NSO's, you purchase the company stock at the strike price and could choose to either hold onto the shares or sell the stock. If the company is pre-IPO (has not gone public yet), typically your only choice is to hold onto the shares.
When you exercise your NSO's, you are subject to ordinary income taxes on the difference between the strike price and the fair market value at the time of exercise. If you choose to hold onto the stock after exercising, any proceeds from future sales will be subject to long-term capital gains taxes if the shares are held for at least one year.
Every situation is unique, but generally speaking, it can be most tax efficient to exercise your NSO's before your company goes public (while the fair market value of the shares is likely low) and then sell them after the company is public and you have held the shares for over a year. There is obviously the risks of the company not going public, or that the share price goes down in value, so it is important to think things through and have a plan ahead of time. For public companies, exercising NSO's subjects you to ordinary income tax on the fair market value of the stock (minus the cost you pay for the shares), so many people choose to immediately sell when exercising and essentially treat it like a cash bonus.
It is important to work with a tax professional to understand the tax implications for your specific circumstances.