How can I set the 255,255,255 cells to transparent?
In ArcGIS desktop I can do this by setting the "Display Backgroud Value (R,G,B) to transparent. I don't see an obvious way to do this in the Silverlight API.
Have you tried changing the image format of your layer? Might be that the format you are currently using does not support transparency. If you set it to png, your problem might solve itself.
(layer as ArcGISImageServiceLayer).ImageFormat = ArcGISImageServiceLayer.ImageServiceImageFormat.Default;