Indeed. I have the same problem and as far as I can tell, there is no workaround.
For many years, Microsoft has been warning us that the whole "Interact with Desktop" concept was one day going to go away. With Win7, it has.
In my case, my Service can be run "blind" -- with no user interaction. But that leaves the user with only minimal control (start / stop only), no clean/simple way to make settings changes, and a severe lack of activity feedback.
The solution is to bite the bullet and rewrite the service so that it has no user interface and communicates using an external control program via RPC or other mechanism.
see: http://social.msdn.microsoft.com/Forums/en-US/csharpgeneral/thread/ea6bbfac-a472-46c3-afb3-953a3d100fdf/
-- Dan
P.S. You can turn off the Interactive Service Dialog Detection service, but that only "cures the symptom," not the disease.