I followed this little guide.
http://cs.elderscrolls.com/constwiki/index.php/Paintshop_Pro:_Creating_Inventory_Icons
I moved the file into the "textures" folder because I've seen it look there for stuff frequently so I thought I'd toss it in there. I went to the item in the construction set, opened it's edit box, and clicked the rectangular box on the bottom that is to the left of the icon slot. I then selected the dds file and a little window popped up that said "Invalid Directory." That is all it said. So I moved it to the "data" folder because that's where it first brought me to. Same thing.
Where do I need to move it for it to accept it?
The item I'm making an icon for is an apparatus (if that in any way affects where I should place the file.)