Cannot add domain accounts to SQL Server 2008

I am trying to create a lab environment with 2 VMs, both have Windows Server 2008 R2 joined to domain called fz.local

Server 1: ad.fz.local running AD

Server 2: sql.fz.local running SQL Server 2008

both can see each other and ping.

I created a domain account in AD called sp_admin. Now when I login to sql.fz.local and try to add this user as NEW LOGIN to sql server 2008, I get error saying sp_admin not found. Strangely I can browse this user and select it from sql server search but as soon as i press OK I get this error:

TITLE: Microsoft SQL Server Management Studio
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Create failed for Login 'FZ\sp_admin'.  (Microsoft.SqlServer.Smo)

For help, click: http://go.microsoft.com/fwlink?ProdName=Microsoft+SQL+Server&ProdVer=10.50.1600.1+((KJ_RTM).100402-1539+)&EvtSrc=Microsoft.SqlServer.Management.Smo.ExceptionTemplates.FailedOperationExceptionText&EvtID=Create+Login&LinkId=20476

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ADDITIONAL INFORMATION:

An exception occurred while executing a Transact-SQL statement or batch. (Microsoft.SqlServer.ConnectionInfo)

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Windows NT user or group 'FZ\sp_admin' not found. Check the name again. (Microsoft SQL Server, Error: 15401)

For help, click: http://go.microsoft.com/fwlink?ProdName=Microsoft+SQL+Server&ProdVer=10.50.1600&EvtSrc=MSSQLServer&EvtID=15401&LinkId=20476