There is no need for EPS before importing the image into Illustrator. That's just silly wasted effort. EPS is a "meta format"; just think of it as a "box" or a "wrapper" into which you can drop a bunch of different object types (raster images, vector paths, text) that can be understood by a PostScript device. You can import the raster image (JPEG, whatever) directly into Illustrator. There is no need for it to be contained in an EPS "wrapper."
Forget Layers. You're just confusing yourself. Has nothing to do with your problem.
...obviously im missing a step.
Bluntly, the step you are missing is reading the operator's manual. You're relying on cheezy online "tutorials" in an effort to use a rather complicated program without having to understand it.
I then go to live paint to select areas to fill...
What does that mean; you "go to live paint"? State exactly what you are doing; click-by-click, tool-by-tool, command-by-command. Use the terminology of the program. (Tool tips tell you the names of the tools.)
ALWAYS state what version of the program you are using.
This was done by merely copying your screenshot from your forum post and pasting it into CS3:
JET
