This problem suddenly developed for me as well. It seemed to coincide with my upgrade to 2.0.6 from 2.0.4, although the avatar problem didn't become known until last night. The upgrade was a week or two ago.
I too am unable to upload certain files as avatars, with a "file too big" error message being generated, even though the file I'm trying to upload is 6k less than the max. limit.
To thicken the plot a little, another admin and one of the users are having the same problem, but are getting a different error message, theirs saying to contact the system administrator (me), referencing line 592 in admin_users.php. (Same deal, but from their perspective, program-wise, instead of the admin's.)
To thicken the plot a little further, I rolled back to 2.0.4 - did a clean install - and restored my database. The upload problem is still there, and it still reads "2.0.6" in the copyright stuff at the bottom, making me wonder if something in the upgrade to 2.0.6 changed something in the database which is affecting avatar uploads, although I did hack the config table, and everything looked exactly the way it should be.
Template(s) used: Chronicles
Any and all MODs: n/a
Do you use a port of phpBB: No
Version of phpBB: 2.0.4 (with possibly a few remnants of 2.0.6)
Version of PHP: 4.3.4
Which database server and version: MySQL 3.23.54
Did someone install this for you/who: No
Is this an upgrade/from what to what: 2.0.6 from 2.0.4, and also 2.0.4 clean install with a few remnants of 2.0.6 from the database
Is this a conversion/from what to what:
Have you searched for your problem: Yes.
If so, what terms did you try: Tried checking PHP code, in the SQL data, by reinstalling an older version, by altering parameters, etc.
State the nature of your problem: See post above.
Do you have a test account for us: Feel free to sign up for one at the URL given above.