Drag the shape layer in between the white layer (Layer 1) and the photo layer (Layer 0). Click on the top layer (the photo layer) and then from the Layer menu choose Create Clipping Mask or press Command-Option-G (PC: Control-Alt-G). The photo layer will only be visible within the pixels of the shape layer immediately below it.
In order to edit the shape of your photo, you have to either add more pixels to the copied Illustrator layer where you want the photo to show, or erase pixels in areas where you don’t want to see the image. To give yourself a little more flexibility, consider turning the shape into a layer mask.
If you’ve already pasted the shape from Illustrator and pressed Return to finalize the size, here’s what you do to create a layer mask: press-and-hold the Command key (PC: Control key) and click on the thumbnail of the shape layer to make a selection in that shape. Click on the photo layer to activate it, and then click on the Add Layer Mask icon at the bottom of the Layers palette.
If you want to go directly from Illustrator to creating a layer mask, well, you can’t. You’ll have to paste the graphic, hit Return, and then follow the steps above to make a layer mask.
Creating a layer mask offers one big advantage over the clipping mask: you can apply filters to or paint on the layer mask to change the mask.