If someone were to sell bitcoins on localbitcoins.com in exchange for paypal my cash cards, which were then deposited into paypal. Is that legal as long as any taxable gains received in the transaction are paid? If the amount is under $500 per day and $4000 per month would there be any requirement to know the customer or comply with anti-money laundering laws?
There is no clear-cut answer to this question. But based on all the information available, you should be okay since you are acting as a merchant/agent for PayPal (which is licensed in every state) and since you don't hold customer funds on account like an exchange.
The concern ...and a very valid concern, would be the risk and exposure to charge-back fraud.
Since Bitcoin is broadly regarded as property by the US government, it would be simple exchange of goods, which would be legal in nearly all cases. However, if your earnings for working are in Bitcoin and you try to convert them to fiat currency, especially in a bank or digitally in general, might be regulated or taxed.
A lot of transactions on LocalBitcoins are with cash in person though, and this is a a tad more hazy as in a few cases it could be regarded as tax evasion.