Only 1. is correct. The subject is underlined, the verb phrase is in bold. "better" is a modal auxiliary (Cf. had better) and the infintive verb "work" is its object. If a verb functions as the object of a modal, it never carries tense. For example,
It must work, It should work, It can work, It has to work, It could work, It would work, and so on. Sentence 2. is incorrect because "works" carries tense.
1. Itbetterwork. (work is an infinitive verb)
2. Itbetter *works. (s is a tense marker)