I had the same problem. It is NOT a WordPress issue, but rather an Apache config issue.
If you have access to your Apache httpd.conf file, change this line:
AllowOverride None
to:
AllowOverride All
As mentioned in the httpd.conf file AllowOverride controls what directives may be placed in .htaccess files.
So you can adjust the AllowOverride directive to whatever tickles your fancy, but setting to All makes WP work as long as you include this as well in your .htaccess file in your wordpress dir:
Options -Indexes
DirectoryIndex index.php index.html index.htm
If you don’t have access to your httpd.conf file, and you cannot create the above .htaccess file… contact your provider… and good luck!
