Instagram puts the blame for its strict no nudity policy on Apple
Because Instagram is looking for a wide audience, it needs to work with Apple's own regulations which prevent nudity on apps in the App Store, unless the specific apps are restricted to those 17 or older. If Instagram did not police itself and allowed nudity, it would prevent the app from being made available in the App Store to those under 17 (in theory).
What makes this difficult for Systrom, is that Instagram supports artistic freedom. But he admits that there are some tough calls that have to be made. It should be pointed out that pictures of breastfeeding women are allowed on Instagram, as are images of post-masectomy scarring. Other images of female nipples will continue to be removed from the app, so that those iOS users under 17 can still use Instagram.
Interestingly, Twitter carries a 4+ rating from Apple, even though you are apt to find some images on the site that would normally require a 17+ rating to see. While Twitter and Instagram are not exactly alike, Apple's treatment of both should be when it comes to nudity.