Hi, I've been pulling my hair out with this for about 2 weeks, here is what I've found so far.

My iTunes library is Apple Lossless which is converted to AAC when syncing via iTunes

Didn't seem to matter whither it was AAC or MP3, with a folder.jpg or without, no album art via iPod.

After reading similar stories on a VW UP forum I tried an SD Card in slot 2.
As I couldn't use iTunes to sync to SD I used DB Poweramp to copy and convert to AAC.
No album art and Mp3tag didn't seem able to embed artwork back into the AAC files.
Next step was to try converting to MP3 rather than AAC
Album Art now showing on PC but not in car.

Album Art can't be larger than 500 x 500 pixels.

Resize album art, success at last.

After all this I now have an SD card full of MP3 files showing album art.

I've also had success with AAC files ripped via iTunes as long as it's 500 x 500 pixels.

Next step if I can summon the energy is to try the iPod again with resized album art.

Hope this cuts out some of the trial and error for you.
Let us know how you get on.

Neil.