When you add devices to the Ciscoworks 2000 inventory there are options for Local and TACACS usernames and passwords.
How does Ciscoworks know whether it is being authenticated against TACACS or locally configured parameters
It doesn't, and it doesn't care. The credentials interface in RME 3.x was very confusing, and it was simplified in 4.0. Basically, it would be best to fill in TACACS+ credentials as much as possible as local credentials aren't used for all device types.