I\'ve created more projects using ReportViewer 2005 and 2008 in local processing mode than I can count on my hands. All Visual Studio 2005 or 2008 ASP.NET web forms projects
I had the same problem, but then move the report and the entities classes to another project separate from the WebAplication, when I did that, the wizard show another options other than DataBase Connection, so I add an Object DataSource to the C# Library. Then I use this post to retrieve the report definition and embedded to the .aspx, hope this help!!