Well they’ve updated the Xbox LIVE Code of Conduct here is a brief capture of what the update allows…

“The recent update to the Xbox LIVE Terms of Use and Code of Conduct which will allow our members to more freely express their race, nationality, religion and sexual orientation in Gamertags and profiles. Under our previous policy, some of these expressions of self-identification were not allowed in Gamertags or profiles to prevent the use of these terms as insults or slurs. However we have since heard feedback from our customers that while the spirit of this approach was genuine, it inadvertently excluded a part of our Xbox LIVE community. This update also comes hand-in-hand with increased stringency and enforcement to prevent the misuse of these terms.”

Here is the link to the latest Online Policies / Code of Conduct. As stated on their site please be sure to reread this document once in a while because Microsoft will update it periodically. Some games and events may also have additional guidelines that govern your use, so be sure to review them as well.