It fillets fine for me. as Danny said there are 3 edges there. THe other thing it looks like to me is (And something I like) is the filleter doesnt just "fail" anymore with larger values. It actually "DOES" the fillet under the surface.(I suppose as it becomes more sofisticated it will get that trim right also) This happens alot when filleting an egde "past aother edge". Something I look forward to.

Anyway, a good practice to make it work, is to start with the samller number and work up. For instance with your model, if I start with 1.5 inch fillet, I get the funcky fillet. Cant get it back unless I quit fillet and start over. Start with .5 and see what happens.