Unfortunately I decided to go in guns a blazing and took out D'ak Taan. However, he did not drop the dagger. I have double check the area many times. And the Mayor of Black Root still wants it. Will this screw up my game or is this a sub plot? If I can;t get this dagger will I miss out on a series of quests? Finally, is there a way to hack this item into my backpack? Thanks!
No containers there. The dagger, as well as other some other loot, is in D'ak Taan's inventory. It won't screw up you game, but you will miss out one of the game's endings. There might still be hope, though. I learned this just recently so I haven't tried it out in any of my games just yet, but rumor has it that you can convince the mayor of Black Root to give you the taxes and rejoin Cumbria if you have the appropriate Tarantian newspaper (the one that is just casually laying on the street in the middle of Dernholm, to be exact) in your inventory. Might as well give it a go, eh? There's the tax retrieving quest, plus one more quest Preator gives you after that one if you have enough persuasion. You will miss that out if the newspaper trick won't work, but then again, if it's not against your character's morality, he can always retrieve the taxes by means of theft or murder and do those quest anyway.
Indeed I stumbled across the newspaper method however I have no idea whether or not it will work after accepting the quest for the dagger.
I just did some testing and to my surprise, there is one more option. You can steal the taxes (one can use a fate point if he considers the quest worth it) and then blatantly tell the mayor that you did so, pointing out that his Tarantian guards are ineffective and therefore convince him to rejoin Cumbria. Once again Arcanum amazes me with its variety of options. PS. What's important in this particular case, this option does work after accepting the dagger quest.
I bet Virgil or another follower picked it up on his own without telling you. Check their inventories. Happens to me all the time (although only with loot on the floor, not in a corpse)