We've got a version with compatibility for Windows 7 in internal testing. The specific problem mentioned here is fixed, but things are actively changing so I am not sure exactly when it will be released (we already had to do a tweak for the latest beta).
As noted, dragging and dropping images onto LogonStudio works around this problem. You can also drag them off LogonStudio onto the desktop or a folder to create a .logonvista file.
Microsoft's new method is very convenient for OEMs, but the 256kb limit is a showstopper for arbitrary images. I understand why they did that; still, many of the wallpapers they ship with are close to 2Mb for a reason. If you cut them down to 1/8 the data, you get visible artifacts. It may work for some images, for some people, but if you've got 1920x1200 screen with a high-detail or high-contrast image you're going to notice the difference.
