Inlinefeatures wasn't working for a number of reasons. Some of those are in geotools (see linked bugs).
Some were in geoserver, however. There's a nicer way to handle certain kinds of inlinefeatures now (i.e., you can reproject them), and the TemporaryFeatureTypeInfo class had some confusing data stored inside it (like an unused extra featuretype).
Patch for 1.5.x/trunk is attached.