The manual says that when you pickpocket, you take what is in their purse, girdle, pockets, etc, meaning that they have to be carrying it in those 16 slots in their Backpack, not in any of their Equipped slots. You can't very well walk up to someone and pickpocket the Splint Mail she's wearing. Now, I have found that this is GENERALLY the case. It is impossible to steal the clothes of anyone's back, but I have filched weapons out of people's hands, and even rings off their fingers. (Man, are these guys asleep or what?) My version does not let me pickpocket Drizzt's scimitars, however.
The weirdest item I've stolen is either when I pickpocketed a 60-pound dead kid off a priestess (how the hell do you not notice that?), or when I managed to steal a guy's scalp while he was still alive.
The idiot didn't turn hostile, either. I sure would, wouldn't you?
As for risking your reputation, not all "civilians" lower your rep when you kill them. For the most part, if there's a chance they're going to attack you, rob you, or even cheat you, you can wipe 'em out with impunity. And there are even some perfectly normal folks who you can whack without losing Rep--maybe they're Evil or something.
Always ID quest items before handing them in. Who the hell CARES how much money or EXP you're getting, if you're losing a great item?
P.S.: Pickpocketing at less than 100% is POSSIBLE if you have Algernon's Cloak--though it's still not advisable.