I was going to post this yesterday, but you guys seemed to be doing fine on your own...
http://forums.wowace.com/showthread.php?t=15439
If that's TL;DR for you...
- Image dimensions must be a power of 2 (up to a size of 1024)
- The image must be a .blp or a .tga (there are several utilities to convert images to/from .blp here on this site - I use BLP2PNG myself)
- If you want alpha in your image (and you're using .tga rather than converting to a .blp from .png) then you need to save it as 32-bit (that's 8 each for r, g, b and alpha)
/edit: and animations are possible, but they need to be coded in either as an animation group or with changing graphics in an OnUpdate (think flip-book)