Yes, sorry for not posting I forgot...

It was not a Zencart issue. I have an SSL installed and I discovered I could not upload on an unsecure domain. i.e. I could not upload on http:// but when I used https:// it worked OK. So I think there's a problem with the SSL install because I dont have this issue on other accounts on the same server. So to fix this I made the whole Admin area secure.

I have never seen this before. The only other times I have image upload problems is when permissions are not set to 777.