I have had this issue since version 1.2. My theory: when the install is in a subdirectory, WordPress doesn’t know to look upwards in the file structure for the .htaccess file. That’s why it says it doesn’t exist.
For example: ../ for the path instead of ./ or just /
So it might be an issue with one of the functions in the /includes area.
I tried the suggestions above and still no luck – I am editing the .htaccess file by hand each time now.
