The first step is to prepare your image and it's mask. While there are many methods to create alpha mapped textures, I'll cover the one I used for this particular picture. I first scanned a regular photo; (using a digital camera will save some steps), and brought it into my 2D image editor. I drew a mask all the way around the outline of the object I wanted separated from the background, in this case, my Dad holding a fish. I then painted the background portion of the image black, and saved the image (ex: Fisher.tga) to my textures directory. I then reversed the mask, and saved that image as Fishermask.tga. It's important to use TGA format as it supports transparency masks.

Next, with the image loaded into the tS Image Browser, I hovered the mouse over it and could see it's size in pixels. In order for the image to be mapped correctly, the plane primitive and the picture size should have the same aspect ratio. I create a default plane primitive with a single click, and then open the Object Info dialog with a right-click on the Object Tool. In this case, the image size was 685 X 1373, so in the Object Info size editboxes I typed 6.85 (X) and 13.73(Y)and hit enter. Note that I moved the decimal point over in order to keep the plane at a manageable size. More simply put, if your image is a standard 800X600, make your plane 8 units by 6 units. If you then need to scale the plane, be sure to toggle Grid Mode on to preserve the aspect ratio.

Next, Open the Material Editor then right and left click on the Color icon to open the Color channel and Library. Select texture map(ex: Fisher.tga) from the Library and then close Library. Browse to your texture in the Image browser and select it by double-clicking. Click and hold on the Transparency selector in the Color panel, and then slide up and choose 'transparency map'. A sub panel appears where you can browse to select the mask image you want to use (ex: Fishermask.tga).

Open the Reflectance channel with again a right and left click on its icon in the main preview pane of the Material Editor. From the Library, select 'Constant'. This helps eliminate any stray fogging or reflections from the portions of the mask that you want to be invisible. Your setup should now resemble the example below:
Paint the plane by clicking the Paint Object button.