I think you're absolutely right Sportster. I did some digging on marine exhausts and companies that have been in the marine exhaust bussiness for a long time have several different types of mufflers for different engine configurations, mainly based on their position relative to the water line, and the type of engine. You're doubly correct in the fact that our motors sit pretty low. As the matter of fact, looking it, I'd guess the water line is right about at the head (when not on plane). It would be easy to imagine the water line coming higher than that if say a wave swamps the back, or I'm backing up in chop or any number of conditions.
Looking at the original exhaust system, we can note that the exhaust starts above the water line (WL), arcs high, then dips low (below the WL), then up, then down (2nd resonator), then up and down again (outlet). There are a series of times where the exhaust must come above the WL when not on plane. I believe this prevents the water from ever backing up into the head. So my idea to turn the JPipe and have it dump sideways into the waterboxes that are above the water line, then down to exit (slighly above WL) falls out. It would be too easy for water inside the waterbox to flow back into the engine. The exhaust must make that down and up motion. And I think it has to expand at the lowest point, hence the shape of the waterbox...
Centek makes the "Vernalift", a muffler designed to be partially below the WL.
http://inetmarine.com/centektypicalinstallationdiagrams.aspx
This would probably work well, but they say I need one with 3.5" inlet/outlet for the amount of power I'm pushing. Which in turn means I need a rather large muffler, which would probably also be difficult to mount and require further internal hull modification. Also, it retails for $500...