Fraternities and social clubs enjoy certain tax exemptions under section 501(c)(7) of the Internal Revenue Code, as "clubs organized for pleasure, recreation, and other nonprofitable purposes." For example, the membership dues that they receive are not subject to federal income tax.
In 1976, Congress enacted section 501(i), which provided that social clubs could not qualify for tax-exempt status if they discriminated on the basis of race, color, or religion (though gender discrimination is okay). This provision confirmed the results in the case of McGlotten v. Connally, where an African-American man successfully argued that the local Benevolent and Protective Order of Elks should not qualify for tax-exempt status because its admissions policy discriminated against non-whites.
But four years later in an act to "simplify certain provisions of the Internal Revenue Code," Congress added an exception to allow tax-exempt clubs to discriminate on the basis of religion. The new exception applies retroactively from 1976.
Knights of Columbus, the world's largest Catholic fraternal organization, which would continue to be tax-exempt. its membership is limited to "practical" Catholic men age 18 and older, and "a practical Catholic is one who lives up to the Commandments of God and the Precepts of the Church."
Section 501 Exemption from tax on corporations, certain trusts, etc.
(a) Exemption from taxation. An organization described in subsection (c) or (d) or section 401(a) shall be exempt from taxation under this subtitle ***
(c)(7) Clubs organized for pleasure, recreation, and other nonprofitable purposes, substantially all of the activities of which are for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder.
(i) Prohibition of discrimination by certain social clubs. Notwithstanding subsection (a) , an organization which is described in subsection (c)(7) shall not be exempt from taxation under subsection (a) for any taxable year if, at any time during such taxable year, the charter, bylaws, or other governing instrument, of such organization or any written policy statement of such organization contains a provision which provides for discrimination against any person on the basis of race, color, or religion. The preceding sentence to the extent it relates to discrimination on the basis of religion shall not apply to—
(1) an auxiliary of a fraternal beneficiary society if such society—
(A) is described in subsection (c)(8) and exempt from tax under subsection (a) , and
(B) limits its membership to the members of a particular religion, or
(2) a club which in good faith limits its membership to the members of a particular religion in order to further the teachings or principles of that religion, and not to exclude individuals of a particular race or color.