DNS configuration:
No, your configuration is correct.
On all NICs of the lan, the preferred DNS server should be your DNS server. In forwarders you configure outside servers to forward to.
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I re-read your question:
Though this is a pain in the butt, you may have to do it this way:
You provided me the best clue in this paragraph:
""I have tried removing the workstation from the domain, rebooting, adding the domain back, rebooting again. This solves the error, but then all of the user preferences and files are gone (basically it creates a second profile).""
I once had an administrator that was determined to update my domain with new servers. He called my new servers the same computer name. He gave the new servers the same IP address. He added AD and DNS to the new servers. Then, he pulled out my old servers and replaced them with the new servers.
Why didn't it work? The active directory database wasn't replicated over from the old servers to the new servers. We had to add each computer to AD by joining the domain. Then, the old profiles were also stored in Documents and settings of the workstations. So, we had to COPY and PASTE all settings from one profile to the other in order to get the profiles back to normal. It took me 3 weeks and a lot of overtime. But, I was promoted into our domain admin spot.
What you can do is rejoin everyone to the domain and copy and past their profiles from the old profile to the new. I know this is a pain in the arse. But, it may be the only thing you can do at this point to resolve the problem. 2003 server has a blank or corrupt database from improperly removing it from the domain or demoting it at any given time.