I think that there is some confusion about purely transcendental extensions. Note that $k(\sqrt{x})/k$ is purely transcendental, despite $k(\sqrt{x})/k(x)$ being algebraic. Similarly, if we can show that if $k(x, \sqrt{1 - x^2})$ is generated by a single transcendental element over $k$, then $k(S^1)$ will be a purely transcendental extension of $k$.
Consider the purely transcendental extension $k(x + \sqrt{1-x^2})/k$. For simplicity we assume that the characteristic of $k$ is not $2$. Clearly $k(x + \sqrt{1-x^2}) \subseteq k(x, \sqrt{1-x^2})$, so it suffices to prove the reverse inclusion. Notice that
$$
(x+\sqrt{1-x^2})^2 = x^2 + 2 \sqrt{1 - x^2} + (1 - x^2) = 2 \sqrt{1-x^2} + 1.
$$
Hence $\sqrt{1-x^2} \in k(x+ \sqrt{1-x^2})$, which also implies that $x \in k(x + \sqrt{1-x^2})$. Thus $k(x+\sqrt{1-x^2}) = k(x, \sqrt{1-x^2})$ and so the function field of the circle is, in fact, a purely transcendental extension of $k$, hence $S^1$ is rational.
Edit: There is a mistake in this proof that is corrected in my answer here.
It is important to note that the above argument does fail for other curves. For instance, the function field of the elliptic curve $y^2 = x^3 - x$ is $k(x, \sqrt{x^3 - x})$, which is not a purely transcendental extension of $k$.