The sound architecture in Mac OS 8.1 is different from that of previous versions of Mac OS. The sound source must be set to CD to be able to hear PC audio.
PC Setup used to take the setting of the sound source when switching to the PC. When switching back to Mac OS, PC Setup would switch the sound source back to whatever it was. This no longer functions under Mac OS 8.1, so you must manually set the sound source to CD for PC audio to work properly.