My friend is an insurance agent who receives a commission on each
policy he sells. During the year, he purchased a policy on his own
life, naming his wife as the beneficiary. He did not report the
commission on the policy as gross income because he considered the
commission a reduction in his cost for the life insurance. An IRS
agent has challenged the exclusion. Who is correct and what IRS code
or former rulings can help us out?

Was his own life insurance policy necessitated by his business?  Seems
unlikely  - and then he probably could take the premiums as a business
expense.
Unfortunately, it seems to me that he should have asked the company
forego paying him the commission and to adjust the calculation of his
premiums, reducing them to reflect this.
Too late now, however.

Do insurance companies offer other clients "reductions" in their
premiums?  No, so why should he feel that he should special?  He in
all likelihood received a W-2 or 1099 for the income on the
commission.  You can't make up the tax rules as you go.  He's already
received a nice benefit in the commission...he's just being greedy
now.  Case closed.

Additionally, insurance co's. do not make alterations of premiums to
reflect commissions for agents.  You have a high first-year
commission, then greatly reduced commissions in later years.  There's
no need to do that from an accounting standpoint, and certainly no
demand for it from agents.

What he should/can do is legally waive his commission on the sale. 
Instead of paying the company the full premium and receiving back a
commission check, he can simply waive the commission on his own sale.