Thanks to @tannieo for the inspiration for this tutorial. EDIT: Check out her comment below for an even easier solution!
You may not know it, but you don’t have to spend your hard-earned money on ringtones. You can create ringtones from any song in your iTunes library, as long as it’s unprotected (non-DRMed). All you need are two freeware apps and your song. Here’s how it works.
The two apps you will need for this are MakeiPhoneRingtone and Audacity. If you already have an audio editing app, such as SoundStudio or Fission, you can ignore Audacity.
This tutorial assumes you’re using Audacity and iTunes 8.x.
Here’s an overview of the process
First, you will need to trim the song down to a maximum length of 40 seconds. Since you can’t do that in iTunes, you will use Audacity. For that you need to export the song from iTunes, load it into Audacity, trim it, export it from Audacity and import the trimmed version back into iTunes for conversion into the AAC format. Then you can convert the trimmed song to a ringtone.
Let’s go through the whole process, step-by-step
Step 1: Set iTunes to import using AAC
First, make sure you have iTunes set to convert imported files into the AAC format. Select iTunes->Preferences from the menu. In the Preferences window, select the General pane and click the button labeled Import Settings….
In the Import Settings window, select AAC Encoder in the Import Using dropdown and select High Quality (128kbps) or Higher Quality (256kbps) from the Setting dropdown (128kbps should be enough for a ringtone).
Step 2: Load the song into Audacity for trimming
Next, we’re going to load the song into Audacity and trim it down to 40 seconds or less. The easiest way to do this is to select the song in iTunes, right-click it and select Show in Finder from the contectual menu. Then simply drag the file to Audacity to open it.
Once the song is loaded into Audacity, find a part of the song that works best for a ringtone. There’s no hard and fast rule for this, simply go with your guts here. Using the chorus usually works best.
When you’ve decided which part of the song you’ll use for the ringtone, select it with the Selection Tool and then select File->Export Selection… from the menu. Give the file a new name (be careful not to overwrite the original file!) and select the folder where you want to store it. This can be a temporary location, so for easy access, you might want to select the Desktop.
From the Format dropdown, select WAV, AIFF and other uncompressed types. Click the Options button and make sure that the Format dropdown is set to AIFF (Apple/SGI 16 bit PCM) (see screenshot) and click OK. Then hit the Save button in the Export File window.
Step 3: Convert the trimmed file to AAC
As mentioned above, we need to convert the song snippet into AAC before we can turn it into a ringtone. This is where our preparations from step 1 come into play. Drag the file that contains the song snippet that you created in step 2 to the iTunes library. When it’s imported, select it, right-click it and select Create AAC version from the contextual menu. This duplicates the song, but the duplicate is now in AAC format.
Step 4: Convert the AAC file into a ringtone
The last thing we need to do now is convert the AAC song snippet into a ringtone. Launch MakeiPhoneRingtone. Switch to iTunes and select the AAC version of the song snippet you created in step 3. Right-click it and select Show in Finder from the contextual menu. In the Finder window that appears, drag the selected file (that should have a file extension of .m4a) to the MakeiPhoneRingtone window. The song snippet is immediately converted into a ringtone and should now show in the Ringtones folder in the sidebar in iTunes.
Whew!
Now that was a whole lotta clicking and dragging things around. I admit, this process may not be very straightforward. But at least it’s free 
If you know of an easier (but still free) way to create ringtones from iTunes songs, feel free to add your comment below.
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As mentioned on twitter, you can do this with just iTunes.
Step 1: the same
Step 2: ⌘-i the song, go to the tab ‘options’, check the boxes for start and stop time and set them to a 30-sec part (I used 30 secs, just tried 40 and that works too.). You can use the first 30 seconds, or take a piece from the middle after some experimenting. Close the window.
Step 3: with the song selected, click ‘Advanced -> create AAC version’. When it’s done importing, you can change the settings for the original song back by unchecking the boxes in the option-tab.
Step 4: right-click your aac-file and select ‘Show in finder’. Then delete the aac-version from your library, but not your harddrive. In the Finder window, rename ‘.m4a’ to ‘.m4r’. Double click the file to import it in the iTunes ringtone library.
Done!
As a bonus you can use these sounds for your alarm as well.
Holy cow! Now that’s elegant! And I didn’t know that simply renaming the file from .m4a to .m4r would work. That really poses the question why Rogue Amoeba had to create an app to do that. Maybe they wanted to get the word out about Fission
Anyway, thanks for the great tip!
This article seems to be for iPhones only; the first hint of this was your mention of MakeiPhoneRingtone. Can you expound further on the topic by expanding it to other phones?
Ed, of course you’re right. This article only works for the iPhone. Unfortunately, I’m not too familiar with any current phones besides the iPhone. I’m guessing the specifics for different types of phones are quite diverse, so I can’t give you any generic instructions that will work for all phones. But the basic process of trimming a song down to a certain length and then exporting it as an AAC (or other format) should apply for all phones.