Tommy,
I can throw a few things out at you to try, but if you hit a brick wall, you can always reach out to Andy over at Ultimarc via email. I've always found him very responsive to these kinds of questions.
1) You say Player 2 Joystick Down sends F12, so I'm guessing you are using either the IPac Programming Utility or a 3rd party app like Chris Stuhr's "KeyThis!" (link:
http://retroblast.arcadecontrols.com/files.html) to see what keycodes are being generated. If not, I would suggest that you use KeyThis! to show you exactly which keycodes are being sent by the encoder for those Player 2 controls.
2) There is an older and a newer version of the IPac Programming utility, and you need to use the version which is compatible with your encoder (based on how old it is). There should be a date stamped on the encoder. There's more info on this on the Ultimarc site, in the IPac section. If you are using the wrong version of the software, you won't be able to reprogram the keycodes. This may contribute to your timeout error.
3) Jumpers. I don't know exactly which version of the IPac you have, but you may have "MAME / ALT" jumper pins on the board. If you do, put the jumper in the MAME position. This overrides any custom programming, and gives you the default keyset. That may solve your problem right there. Also, if you DO want to reprogram the keycodes, this jumper needs to be set to ALT. This may also contribute to your timeout error.
4) USB vs. PS/2. You say you are using Windows98 as your OS. Are you connecting your IPac via USB or PS/2? Just a thought, USB can be problematic in Win98. Also, the IPac Programming Utility software needs to know whether you are hooked up via USB or PS/2, it can't tell by itself. This may also contribute to your timeout error.
5) The IPac Self-Test LED. The pattern of flashes when you first power up the computer can tell you a lot. This, and a lot more specific information can be seen on the Ultimarc site, under the IPac tab, in the Instruction section, toward the bottom, under the TROUBLESHOOTING heading.
Hope there's something in my ramblings that helps.

-EVEGames