To report someone, you must always show that (Person 1) is doing something against the rules or exploiting a bug.
The best way in order to do that is go to:
Start>Snip it
Snip it is a great tool for screen shots of your size of choosing.
For example: If you only wanna show the chat log you can make it only the chat log, or only want the photo of the guy no clipping or something, use it on that. This tool is one of the best screen shot tools out there.
Another thing to help you out. After saving it, upload it to like PhotoBucket or something, this helps you in order to place in it text to make it show better.
Make sure you state the name, what hes doing, and why your reporting it. This helps us show what kinda player that guy is and even you.
But remember, saying things back, can also get you introuble as well, due to the fact he can report you as well.
So if you see someone doing something wrong, ask nicely to stop, if not, report them here, and the Staff Team will look into it.