After spending the morning digging through the forum I found this:
It lists 8 things that can be done to address the problem. I have tried all 8. Spent many hours doing it. (re-uploading files, testing, turning things off, testing, clearing cash testing. Nothing works for me. My portfolio site is completely borked except for writing my complaints about this serious “feature enhancement.” How could this have made it through beta testing? Oh thats right, early adopters “we” are the unpaid beta testers.
Here is a follow up to the problem. I found a FAQ that detailed which files that were causing the fatal error. (Here). I did a search and sure enough these two files were both partial uploads. (you can tell by examining file size, side by side, in the FTP client. I use Transmit.) I re-uploaded the files and it seems to work fine now.
So bottom line: the advice given in the forum is spot on — make sure all the files are uploaded correctly. Of course there are hundreds of files to go through and this other guy knew exactly where to look and could have saved me 5 hours of trauma as I repeatedly tried to check each and every little file in the program.
Click Below Link To Solve Yours IMAGE UPLOADING
Problem IN WORDPRESS 2.5
There YOU FIND USEFUL INFOMATION ON
HOW TO REMOVE THT FATAL ERROR !!!
http://vevin.com/wordpress/wordpress-25-image-uploading-problem/