I knew it.
It's really not so bad -- it's just, you know. You're going to hate it.
Well, you're on the same side as the RIAA on this one. Hurts, doesn't it?
Impossible! How can that be?
Well, the RIAA wanted to be able to distribute ringtones of its artists without having to pay them big money to do so (surprised?), and it won a decision last year before the Copyright Office saying that ringtones weren't "derivative works," meaning they didn't infringe on the copyright of the songwriter. It's a little more complicated than that, but essentially, if the RIAA hadn't won, ringtones would cost even more, since no one would be able to make them without a license from the songwriter.
But I just want to make ringtones from the music I already legally own.
As long as you're talking about music you've ripped from a CD, go ahead -- no one's trying to stop you. Since making a ringtone doesn't count as a derivative work, you're not infringing any copyrights. Just don't sell or distribute anything, and you should be fine. Funny how this piece of advice keeps coming up, eh?
So why won't Apple let me make ringtones inside iTunes with tracks I've ripped from CDs?
Judging from the fact that the iTMS EULA prohibits the use of downloaded files as ringtones, we'd say it's more than likely because Apple's contracts with the various labels represented in the iTMS specifically forbid it. We haven't seen them, but we'd bet that ringtones -- and the licenses for using songs as ringtones -- have their own lengthy section in Apple's contracts, and that Apple isn't allowed to sell files for use as ringtones without coughing up more dough. Steve has said as much, after all. Otherwise the selection would include more than just the 500,000 songs you can get right now.
We're still not exactly happy with Apple's decision to lock out the consumer like this. For example, why can't we use our own GarageBand compositions as ringtones? We obviously own the rights to music we create. But we can certainly see why the labels would insist on pricing ringtone rights separately, since it's such big business.
So basically it's legal to make ringtones for my own personal use, but only because of the RIAA -- and I'm not allowed to use iTMS-purchased music, and I still have to jailbreak my iPhone or use something like iToner.
Damn, why do even the good answers suck?
Hey, it could be worse -- Apple could have dropped the price of the 8GB iPhone by $200 just two months after... oh, balls.