He's called Zax in the Japanese script, and Zack in the English. And he's most certainly dead. He was shot into oblivion and then officially recorded as deceased in Shinra's records. That was about a day or two before Tifa found Cloud, barely conscious, at the Sector 7 station. Tifa only met Zack once, when he came to Nibelheim just before the massacre, and Zack was Aeris' girlfriend for a while.

Zack kind of represented who Cloud wanted to be, so when Hojo's experiments messed up Cloud's mind, the "illusory life" took hold and he re-created his past into something more heroic and idealised, based on Zack's experiences.