YouTube Capable of 1080p Now (11-18-2009 Update)

Yes, YouTube now supports resolutions of up to 1080p. They've become very versatile now. Instead cramming everything into the same box, they now create a custom video based on your upload's settings. Here are some of the variables:

Player Size.
There are basically three sizes of players. The first is the smaller 640x360 box, with the description (or ads) to the right of the video. There's the SD sized player that's around 853x480. It's bigger, so you have to scroll down to view the description, or ads. You can toggle between those first two sizes by pressing the button at the top that looks like this:
The third player size is full screen. Obviously, the resolution depends on your own settings.

Video Resolution.
Many times, the file stored on YouTube's servers will be the native resolution of your video. This is very good. No need to have extra distorting because of an unnecessary resize. If you have a larger (HD) video, it will often be resized only for the lower quality version. The big one stays as is (it will be recompressed though). HD is now available at resolutions of up to 1920x1080. And like the other sizes, you will still get a custom size based on your video.

Quality.
I'm pretty sure everything is converted to AVC (H.264) now. YouTube's quality has improved dramatically because of that one change. So what will your video end up like in the end? I'll admit, I don't pay as much attention to that anymore, because they're doing a much better job in quality. But basically, if your video is really small, or slow moving (i.e. screen captures / still images / animation), you just get a normal quality video, probably of that same resolution. Even though you may not have the HQ button, these videos can actually look pretty nice. I've done screen captures that end up as 852x480 videos, even in normal quality! If your video requires a little more bandwidth, they'll assign you an HQ video. If you like the badge of honor of having the button, you'll be happy. But don't worry; even the normal quality videos can look quite good now.

And what's the other option? Oh yeah, HD! For 720p videos, the video bitrate is increased to about 2,500kbps; and for 1080p it can go as high as 5,000kbps! For internet video that's pretty darn good. I should mention there's a downside to HD: compatibility. There are still many, many, users whose PC's (laptops especially) or internet connection speeds aren't up to par to handle HD. So don't count on all your viewers to watch in HD. But it still is neat that it's there. Give it a couple years, we'll get there. One more thing: if you decide to go with 1080p, remember that in widescreen there are 1,152,000 more pixels than with 720p. So it will take you longer to render, and upload if you increase the bitrate to account for those extra pixels. If you're in a hurry to get a video out, you may want to reconsider.

Audio.
Audio is the one constant. It becomes a 44.1Khz 128k AAC. So don't worry about inferior audio just because you don't have an HQ/HD button.

Uploading Recommendations.
You really don't have to do anything crazy anymore. YT actually has good advice on their help page. ;) Keep it as close to the original as possible. Just be sure you're uploading progressive frames. Either deinterlace of inverse telecine if interlacing is visible in your video. Here is a link to a video describing interlacing and how to convert to progressive. Crop out any bars/pillars on the top/bottom/side.

For high quality audio I still recommend uncompressed (PCM), or losslessly compressed (Apple Lossless for example) streams. For extra care, you can render your audio at a 44.1Khz sampling rate (since most video cameras sample at 48Khz). Theoretically it wouldn't be as good to render 48Khz compressed (AAC or MP3) sound, then have YT decode it, then recompress to another sampling rate and bitrate. Not all programs give you the option for lossless audio, especially if you're rendering to MP4. So you may just have to pick the highest bitrate you can.

In my opinion, it's probably more important to produce your video well than to use some magic upload settings. Light it well so you don't have a noisy image. Use a microphone. Study up on quality video production. Garbage in, garbage out.