I just turned on avatars and I guess they're working since I have one, lol. I enabled the ability to use avatars from my gallery (just 2 right now), link to offsite avatars, or upload avatars to my gallery. Any of the 3 options should work.
Guidelines for avatars are as follows
1. they must be 80x80 pixels
2. they must be under 8KB in size
And here's a recommendation. If you're using an image with any whitespace around it, I'd recommend altering the image so that the whitespace is transparent. phpBB alters the background color of each post so every other post, your avatar will look silly. That may not make sense since I suck with words, but trust me
At any rate, enjoy the use of avatars.