I would recommend placing the decoupling capacitor close to the ATMEGA's Vcc and ground. Maybe you can create some space between the crystal and D4.
Ideally the decoupling capacitor (yes, the 0.1uF) should be as close to the IC's VDD/GND pins as possible. If you fail to do this then Grumpy Mike will jump into your thread and post a link to his (excellent) tutorial at http://www.thebox.myzen.co.uk/Tutorial/De-coupling.html
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