First start a server (single or multiplayer, it doesn't matter) and build a white wall...
Hit one of the middle bricks with the wrench...
Choose the desired item (in this case I'm using my Buster Sword)...
On item position, choose East...
Press F8...
Zoom in and take a picture...
Open the screenshots folder, right click the picture you just took and open it with your favorite photo editing program...
Now edit out the white using a combination of select area>Deletes and Magic Wand...
Once you're done, open the given template download (at the bottom of post) and open it with the same program...
Click the item picture, copy and paste it into the template picture, resize/rotate or whatever to make it fit and look right...
Save it as the name of your item to Add-Ons/ItemIcons...
Now open your item's .cs and look for "iconName" and change the words in the parenthesis to the name of your icon...
Now you might notice it's really dark in game...
Simply go back to the template in your picture editing program and lighten the item part using filters and...
Tada, it's finished.
And here's the template for you to use.
Please sticky.
