How many items were you trying to purchase, anyway?
In order to use the buy one get one free coupon, you'd have to get at least 3 items, not 2.

Item #1: You pay full price for this
Item #2: Free, due to the store's BOGO sale
Item #3: Free, since you already paid full price for item #1.

I work at Kmart and we certainly do take BOGO coupons, but I could see the register not accepting the coupon when it's used in conjunction with a BOGO sale. About the only real corporate rules about coupons that I know of are that they cannot be expired (duh) and they cannot be printed off the Internet. Managers (assistant and store managers, not service desk supervisors) do have the power to bend the rules some in order to satisfy the customer.

I think you should have politely requested to speak to the manager on duty about the conundrum - you may have gotten more results that way.