I think doing the thesis is your best option. PhD admissions basically care about one thing: are you going to be successful in their PhD program or are you going to come in, suck up a few years of a PI’s hard-won research dollars, and then flame out before finishing. Your goal is to prove that you will do the former, obviously. So let’s think about what sorts of things you need to show in order to prove that:
[ul]
[li]Show that you can succeed in the coursework: Your undergraduate GPA may leave some to be desired, but you have worked for a while and now have success in a graduate program to show that you can handle it. This shouldn’t be an issue at this point.[/li]
[li]Show that you you can succeed in research: Working at a government research lab will help here, but you said you were not in an R&D type role, so that will mitigate that factor to some degree. Your best bet is to do this by doing academic research as part of your MS program.[/li]
[li]Show that will see the PhD program through to completion: Again, the best way to show this would be by actually finishing your research thesis as part of the MS. Moving into a non-thesis option will at best do nothing to help you, and at worst might imply you aren’t serious about the research aspect of things.[/li][/ul]
Do the thesis.