I figured it out.
I added this mod by masino to allow uploading attachments to internal notes.
http://www.openscriptsolution.com/2010/02/26/add-attachment-on-internal-note-in-osticket-v1-6-st-stable(http://www.openscriptsolution.com/2010/02/26/add-attachment-on-internal-note-in-osticket-v1-6-st-stable)
This forum post caught my attention because of the similarity
http://osticket.com/forums/showthread.php?t=7181&highlight=internal+note+alert(http://osticket.com/forums/showthread.php?t=7181&highlight=internal+note+alert)
When I went to /scp/tickets.php and changed this line from
if(!$errors && ($noteID=$ticket->postNote($_POST,$_POST,$_POST,''))) {
back to
if(!$errors && $ticket->postNote($_POST,$_POST)){
It solved the problem and internal note alerts are now being sent out as normal.