I think it is prob eczema or a allergic to something he is wearing.
If he is not getting baths that often it could be making the eczema worse. Also with a child with eczema the water shouldnt be too warm it makes it worse. They need to use dye and fragrance free laundry soap and bath products. Lotion his body as often as you can to keep his skin moist.
It is odd that she is defensive about it. She might feel that you are taking the place as "Mom" in his eyes and be a bit jelous about not being able to spend as much time as she wants to with him. Plus, she could feel that you telling her about it that you think she is a "bad mom".
There is nothing wrong with what you did!
I would ask her if she would like for you to bath him after lunch time since the father is really busy and this will help them out.
I would explain that you think that their might be a possibility that he might have eczema and that it might be a good try to use a dye and frangrance free laundry soap on his laundry. Just to see if this helps...
As a daycare provider it is your right to say something to her about it. You dont want to risk anything being given to your child. If she still fights you on it and since it is spreading I would let her know your concern for her child as well as yours re the rash...and that you need a note from the doctor letting you know what it is and if is contagious to the other children as well.
My daughter goes to a dermatologist for her eczema. He gave us a steroid cream to use on it.
Pediatric Dermatology
Ghali, Fred MD
1325 W Northwest Hwy,
Grapevine, TX 76051
###-###-####
We love him...he even looked at my daughters birthmark and help let us know if it had a risk for be cancerous or not. Which it did and ref us to a plastic surgen to remove it.
Good luck!