I have the same issue. I am on an iPhone 3GS, now running 4.3.5.
When trying to update I get the following error messages: "The iPhone "xxxxx" could not be restored. An internal error occurred", and after downloading the iPhone2,1_5.0_9A334_Restore.ipsw file from the Apple servers to try it that way, I get another error message. "The iPhone "xxxxx" could not be updated. An unknown error occurred (3002)."
Apple says: "Error 3002: If you experience this error while updating an iPod touch (2nd generation) or iPhone 3G, please use the standard update or restore process in iTunes (click Update or Restore)."
So Apple is sending me in circles, since I just tried that and it did not work.