The problem is that the predefined packet filter for DNS lookup in Microsoft Proxy 2.0 is only for outbound DNS requests.
To create a packet filter for incoming requests:
01. In Internet Service Manager, double click the Winsock Proxy Server to display its properties.
02. Click the Security button to display the Security Properties dialog.
03. Press the Add button to add a new filter.
04. In the Packet Filter Properties dialog, select the custom Radio button.
05. Set the Protocol ID to UDP.
06. Set the Direction to Both.
07. Set Local Port to fixed port \[ASCII 148\] and enter port 53.
08. Set Remote Port to Any.
09. Set Local Host to Default Proxy external address.
10. Set Remote Host to allow Any host.
11. Press OK, to return to the Security dialog.
12. Press OK, to return to the Properties for the Winsock Proxy Server.
13. Press OK, to recieve the notice that the Proxy services will be restarted.
14. Press OK to confirm.
15. Press OK after the services have restarted.
16. Press OK, to close the Winsock Proxy Service Properties dialog box.