I'm no expert with art or photo-editing software, but I believe you crop out that bottom side of the template. And, it's 128x; it's not going to look good compared with other templates.
If you are making the head texture just make the head 512 using the 512 template. The size will automatically change to 128.
Really? So I just make a head on a 512x template, and when I upload it to my 128x head it will resize it? I'll test this when I get home(I'm on my phone atm)