Has your son told you why he has this fear? Did it come about from a movie he saw? To get a handle on the fear and anxiety, you really need to find out the origin of it. Anxiety and fear might play a bigger role with your son than you might think. If you are unable to find where this fear is coming from or why its there, it might be a good idea to discuss this situation with a mental health professional or the school counselor. You definitely want to get a handle on this situation now before it becomes even a bigger problem later.
I don't think it will actually harm him to stand when going #2, though it doesn't seem to be the healthiest way (since squatting is seen as more healthy than sitting, one would assume that the further a person gets from squatting the more far from what nature intended).
If he were my kid, though, I would want to help him get over the irrational fear that is causing him to stand up in the first place. My son is about to be 7 and he is afraid of ghosts. It keeps him from walking into dark rooms in our house. I don't think being afraid of ghosts at that age is abnormal, but it is interfering with his day-to-day life (he won't even go into the bathroom if the light is off, one of us has to go with him). When it gets to that point (interfering with living) then I start to think about who he could see, a counselor or a therapist, to help him work on his fear of ghosts. Not on his fear of dark rooms, since that is just an offshoot. In the same way, I'd suggest you have him do some stuff to understand plumbing and toilets. He could talk to a plumber if one comes by to do some work, and have the plumber tell him how a toilet works. Or maybe you could look on the Internet and he could see some schematics of toilets. If he understands that things don't come up through the toilet, let alone zombie hands or whatever he thinks it might be, he will be more likely to sit down. It's more comfortable, which will help sell the concept once he gets over his fear.