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I don't have a solution as to why the extra backslashes are being added. I've purposely avoided IIS since it first came to being.
As for the error you get, probably a dumb question, but do you have read/write access set to your userpics folders and all sub folders?
I've gotten this errors numerous times with ImageMagick, I like it, but it never never likes me. I've been forced to use GD libraries and with much greater success,(so far it has never failed me) both version 1 and 2.
Also worth considering is netpbm, although you will need to configure this library yourself and supply a path in your gallery preferences. Again, I have no clue how this library works with IIS, but I have had limited success with it on Apache based servers.
In sumation, both GD library versions have been rock solid on every server/website that I have had to work on. Not as many options as ImageMagick, but reliable.