Wordpress permalinks on IIS?

The image issue was a permission issue, but simply setting it manually on the original image file or parent folder is inadequate. The behavior of WordPress is that it writes the original file using IUSR to a temporary system directory that is defined in the PHP.ini file. This temp folder does not have IIS_IUSRS permissions on it, so when windows moves this file from the temp folder to the application's upload folder, its final home, IIS_IUSRS only has read permissions, so the permissions are not inherited from the file's parent folder.

To fix this, there are two solutions.

1. Change the permissions on the temp folder giving IIS_IUSRS write/modify.
2. Change the path of the temp folder in the PHP.ini file to a folder that does have IIS_IUSRS write/modify permission.

Here is a good source detailing the problem: http://www.howyoudo.info/index.php/how-to-fix-windows-server-upload-file-inherit-permissions-error/

I chose to move the temp folder in my PHP.ini to C:\inetpub\temp\uploads and also give it permissions. After uploading an image in wp-admin, I was able to access the image (original, not resized) from a browser wihout the 500.50 error.

From source

There's a slightly different web.config at Using Permalinks « WordPress Codex as well as other options for Permalinks without mod rewrite on Windows.

To help other users this issue is due to permissions in IIS and a fix is also here:

http://forums.iis.net/t/1159252.aspx