I have come to the conclusion that I actively hate the new Web Application Project stuff in VS2005. It requires that my code live in some weird folder structure, I don't get to choose what files get compiled into my project, and it uses a completely different compiler (aspnet_compiler). I totally understand why we added this feature, it's just that I think we overreacted to people complaining about how hard it was to build reliable WebForms projects and now have made it harder to build Web Services using ASMX/Indigo. I really wish we'd allowed a developer to choose which project model to use if they're building a Web Service.
In my opinion, if you're worried about having fine-grained control over compilation, you're probably OK with attaching a debugger to a process. With that in mind, here's how an ASP.NET rebel sets up his Indigo projects. Set it up as a class library, reference System.Web, System.Web.Services (and optionally System.ServiceModel and System.Runtime.Serialization if you're building an Indigo service). Unfortunately, you do lose F5 debugging and must either explicitly call Debugger.Launch in your startup code or manually attach to aspnet_wp (XP) or w3wp (2k3), but you regain control the compilation process.