Hello guys - the solution was found! See the email I received from Worpress below. This was exactly my issue, I just confirmed the functionality.
"Hello, thank you for your reply.
> I have checked that images be shown in my email client - in fact, I use two
> email clients and they both don't show images (Gmail and Hotmail).
> Please see attached. I took screen captures of my most recent blog post in
> Gmail and in Hotmail. I also took a screen shot of the dialog box in Gmail
> saying that images are set to be shown.
Hi, this is happening because you have the feed settings set to show a summary at:
If you have that set to a summary images are not included in the RSS feed or in email subscriptions.
To have images appear you'd need to set that to full text.
Let me know if you have any other questions.