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Without looking at the links specifically it is hard to speculate. Realistically the site made it through all Penguin updates unharmed. That has to say something. Disavowing the links will have a negative affect on SEO. It will take time to come back from it. It is expensive and time consuming. I would pose the options to your client and see what they decide. Pros and Cons of both options and let them decide.

Awesome timing!  Thank you for referring me to that link. That definitely makes me a little more comfortable with my original intentions. At the end of the day, it seems that in our case, the subdomain will ultimately produce the best user experience and in the end, that is probably what I should be focused on anyway.

I have a lot of clients just like this guy who have high PR for a site that has had little to no traditional SEO work done. Usually they have a domain that's old and back links dusty old chamber of commerce sites. I would sell him on the 301 re-direct. You have to show him how without the re-direct, he's essentially competing with himself. Most small business owners I've dealt with will cede control if you explain this properly. Now if I read between the lines, it sounds like this guy may have lost confidence in your abilities, which if that's the case, your best bet may just be looking for a graceful exit. If he doesn't trust you as an expert in what you do, you're going to be fighting a losing battle from here on out with him. Worse yet, you won't be getting paid for it. If this is indeed the case and you have honored your agreement with him, I would chalk this up as a learning experience and monitor the site from afar - hopefully it will rank eventually and you can then send him an email to make nice.