One key is you should stress that the Surface Config needs to allow Remote Connections. This is something that may not be obvious since it my SQL Server 2005 allows remote machines to connect but did not have that setting set. Also, I am running with IIS and SQL on the same machine so the reason for remote connections seemed odd anyway.

Remote connections must be allowed when IIS and SQL Server are on 2 different boxes and you need to use TCP/IP protocols.

If you run IIS and SQL Server on the same box, you do not need to allow remote connections. But you need to connect using Shared Memory protocol (click on the Options button in the login page) You can specify Shared Memory as the default value by editing the config.xml file.