CAUTION: Not All Donor Advised Funds Are Created Equal
By Barry A. Nelson | Cassandra S. Nelson
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Donor Advised Funds Table of Questions - VIEW PDF
Reproduced Courtesy of Leimberg Information Services, Inc. (LISI).
Comment
Introduction
Donor advised funds (“DAFs”) have been touted as a simpler alternative to private foundations and many financial advisors advocate the use of DAFs in lieu of private foundations. DAFs allow individuals (the “Donor”) to make irrevocable tax-deductible contributions (e.g., using among other assets, cash, stock, real estate, art, and cryptocurrencies) to a sponsoring organization (the “Charitable Sponsor”). Many national financial institutions have created a charitable arm that serves as a Charitable Sponsor and manages DAFs. Charitable Sponsors earn fees for serving, including investment management fees, and file all applicable tax returns. Examples of Charitable Sponsors, including charitable arms founded by national financial institutions, are Fidelity Charitable, Vanguard Charitable, Schwab Charitable, and Community Foundations such as and The Miami Foundation, Greater Miami Jewish Federation, and The New York Community Trust.
Over the past year, the authors have encountered two families who were advised to establish DAFs for testamentary contributions of $50 Million for one family and over $100 Million for another family. Financial advisors who work for national financial institutions that have created charitable arms or entities to serve as Charitable Sponsors may have financial incentives to guide their clients to DAFs as compared to charitable private foundations. For example, Charitable Sponsors may favor DAFs over private foundations because (i) the Donor, while living and capacitated, retains advisory rights to recommend, but not direct, grants from the DAF to 501(c)(3) charitable organizations (“Advisory Rights”), (ii) the financial institution controls investments, and (iii) upon the Donor’s death or incapacity, the terms of the DAF Agreement, which generally allow the Donor to designate succession of Advisory Rights in the event the Donor is not living or incapacitated, provide how the DAF will be administered or terminated (or if the DAF Agreement does not designate how the DAF will be administered or terminated, then upon the Donor’s death or incapacity, the Charitable Sponsor may control the DAF in its entirety).
The 2022 Donor-Advised Fund Report published by the National Philanthropic Trust (the “2022 National Philanthropic Report”)[1] examined data from 995 charitable organizations that sponsor DAFs and reported that the average DAF account for the years 2017 through 2021 ranged from about $165,000 to approximately $240,000.
The Authors’ Experience
As the authors’ firm has worked with their clients and their teams of advisors and surveyed Charitable Sponsors throughout the country, it has become apparent that some DAF Agreements/arrangements are more comprehensive and flexible than others. The most noteworthy differences amongst Charitable Sponsors in the authors’ opinion are the following:
(i) Some Charitable Sponsors allow DAF Agreements to be modified to permit multiple generations to succeed the Donors to recommend grants upon the death or incapacity of the Donor while other Charitable Sponsors limit succession to the Donor’s children or to one successor (i.e., a trusted friend, advisor, or one generation of family);
(ii) Some Charitable Sponsors allow DAF Agreements to be modified to provide that children succeeding their deceased or incapacitated parents must act by majority if more than two children are then living and not incapacitated or unanimously if two children are then living and not incapacitated in order to request grants while other Charitable Sponsors will take direction from any child without consent of the other or even notice to such other child(ren);
(iii) Some Charitable Sponsors will review grant requests to confirm such requests are consistent with the Donors charitable giving objectives based upon the Donors historical giving or as stated in the Donors DAF Agreement while other Charitable Sponsors will not; and
(iv) Some Charitable Sponsors will enforce an annual cap on contributions and a percentage limit that any one charity may receive while other Charitable Sponsors will permit grants in any amount to any charity so long as the charity is a 501(c)(3).
What is most concerning in the authors’ opinion is a situation in which there is no successor to the Donor or when the DAF successors to the Donor have died or are incapacitated and the DAF Agreement does not allow for further succession. Clients and other professionals should determine how the remaining DAF assets will be handled in such a situation. A critical question for the Charitable Sponsor is who receives the remaining DAF assets if no successor to the Donor is designated, the designated successor is unable or unwilling to serve, or the DAF must terminate based upon the Charitable Sponsor’s rules. The policy of some Charitable Sponsors is that upon the death or incapacity of the Donor and the Donor’s successors, there is no obligation for the Charitable Sponsor to consider the charity(ies) the Donor favored while the Donor was living and had capacity. For individuals contributing significant sums to DAFs during their lifetimes or upon their death, failing to provide the Charitable Sponsor with direction for distributions after the Donor dies or becomes incapacitated or upon the death or incapacity of the last family member or other person succeeding to the Donor’s right to request charitable grants could result in empowering the Charitable Sponsor to make charitable gifts that are neither desired nor anticipated by the Donor.
Clients with DAFs holding assets of $250,000 or less may not be as concerned about designating children or more remote descendants as persons empowered to make charitable requests from the DAF assets upon the Donor’s death or incapacity. In such situation, the Donor may prefer to designate one or more charitable institutions to receive the remaining DAF assets upon the Donor’s death or incapacity. However, the authors have experienced clients who planned to utilize DAFs for ultimate contributions in excess of $100 Million, and who prior to consulting with the authors’ office, had not carefully considered the administration of their DAF upon their death or incapacity. DAF Agreements are generally created from a Charitable Sponsor’s “master form” and signed by the Donor and the Charitable Sponsor. While the Donor is living and not incapacitated, the DAF may only be seeded with a modest amount, with the intent that the DAF will receive more significant funds over the Donor’s lifetime or upon the Donors death or incapacity. While the Donor is living and not incapacitated, the administration of the DAF is typically without complications. The Donors make requests and generally they are complied with by the Charitable Sponsor.
Considering that DAFs began gaining favor around 1990, a 60-year-old who created a DAF in 2000 is most likely still living and has capacity. Accordingly, for many Donors, DAF succession as outlined in the DAF Agreement may not have matured yet. However, as the population of Donors who created DAFs pass away or become incapacitated, it is likely that the Donors’ successors may be surprised if there are insufficient provisions in the DAF Agreement as to who may make charitable requests and the process to do so. It has come to the authors’ attention that not all DAFs thoroughly address the ability of the Donor’s successors to request charitable contributions or provide a default charitable gift when the DAF terminates. Of even greater concern to the authors is that Donors, Charitable Sponsors, and the clients’ financial advisors may not fully consider succession to the Donor’s ability to make charitable requests when creating the DAF, especially where the DAF is nominally funded at creation with the intent to receive a significant gift upon the Donor’s death. The considerations for selecting a DAF rather than a charitable private foundation should take into account the following: (i) how the DAF will be administered upon the Donor’s death or incapacity, (ii) the ability of the Donor to designate successors or a list of successors and how many generations can continue making charitable requests, (iii) what process shall the Donors successors follow to make grant requests if more than one of the Donors designated successors are able and willing to serve upon the Donor’s death or incapacity (e.g., by majority), and, most importantly, (iv) how will the DAF be administered when the DAF terminates (i.e., who will control the DAF), whether because the Charitable Sponsor only allows one or two generations of Successor Advisors, because the Donor did not designate a Successor Advisor, or because the Donor’s designated Successor Advisors are unable or unwilling to act. Even for Donors who designate successors, there is often little or no conversation between the Donors and the Charitable Sponsors on the types of restrictions the Donors can place on their successors, such as whether children (or other individuals) who are designated as successors must act by majority, whether the Donor wishes to limit annual distributions, and whether the DAF must continue gifts to charities desired by Donors, etc.
The authors have met with several clients who already have DAFs in order to review their DAF objectives, compare such objectives to the client’s existing DAF Agreements, and attempt to modify the client’s DAF Agreement with the Charitable Sponsor in order to satisfy the client’s objectives. Based upon such process, the authors realized that, in some cases, their clients were not satisfied with their existing DAF Agreements or with limitations set forth by the Charitable Sponsor, specifically with respect to the Donors ability to modify the DAF Agreement to direct procedures for their successors to follow in order to assure that the Donors charitable desires are satisfied after the Donors death or incapacity. In such situations, the authors’ clients chose to either create a charitable private foundation or move to a Charitable Sponsor that provides greater flexibility and is willing to satisfy most of the client’s objectives.
The DAF Survey
After the authors reviewed the DAFs held by their clients with various Charitable Sponsors and noticed the significant disparity in the flexibility or lack thereof with respect to the Charitable Sponsors willingness to modify master DAF Agreements to satisfy the Donors objectives, the authors prepared a DAF survey for Charitable Sponsors (provided below), with answers to be provided in yes or no format. The authors circulated the survey to various Charitable Sponsors throughout the country and had telephone conferences and Zoom conferences to discuss such. While this is still a work in progress, and only reflects responses from nine Charitable Sponsors (the 2022 National Philanthropic Report states they surveyed over 1100 Charitable Sponsors) the authors have included responses to date. The names of the Charitable Sponsors are redacted but the questions can be used by Donors (and their attorneys) as a tool to compare the survey results to the policies of the Donors existing Charitable Sponsor (i.e., by comparing responses provided by the Donors existing Charitable Sponsor to the responses reflected in the survey). After comparing the responses that the Donor receives to the survey, Donors may request modifications to their existing DAF Agreement. The critical issue and purpose of the survey and this article is to make sure Donors: (i) are aware of the options included in the survey, (ii) determine how important such survey options are to them, and then (iii) decide if they can achieve their objectives with their existing DAF Charitable Sponsor or another more flexible Charitable Sponsor, or if their charitable objectives would be best effectuated with a charitable private foundation. The larger the anticipated donation to the DAF and the more control the client may want as to donations after the Donor’s death or incapacity, the more likely the client may, after careful consideration, move to a charitable private foundation unless there are significant other income tax factors or on overriding desire for simplicity. The responses to the survey reflect that not all DAFs provide the same level of flexibility to Donors.
Community Foundations Compared to Charitable Arms of National Financial Institutions
The authors have found that Community Foundations often are more flexible and accommodating than charitable arms of national financial institutions especially if the DAF is material to the Community Foundation Charitable Sponsor. Although the survey redacts the names of the Charitable Sponsors, it reflects whether the responses were provided from a Community Foundation or a charitable arm of a national financial institution. It is also important to note that Charitable Sponsors may be more willing to work with Donors to achieve their goals based upon the size of the Donor’s contribution. Some Charitable Sponsors advised the authors that they have limited flexibility due to the volume of DAFs they oversee, and the administrative costs associated with enforcement of DAF Agreements. The authors suggest these Charitable Sponsors consider offering greater flexibility based upon the DAF value. The authors believe that if DAF Administrators offer greater flexibility based upon the size of the DAF, even if they charge additional fees for the enhanced administrative time to follow a Donor’s more detailed DAF Agreement, they will have the opportunity to oversee higher value DAFs.
As an alternative to a more detailed DAF Agreement, several of the Charitable Sponsors suggested a Donor created trust where the trustee, upon the death or incapacity of the Donor, unilaterally has the power to make charitable requests from the Charitable Sponsor (the “DAF Trust”). All of the administrative and succession provisions would be governed by the DAF Trust and the Trustee will act in a fiduciary capacity as the Successor Advisor. In such a situation, the authors suggest that an attorney or other licensed professional be the Trustee of the DAF Trust (the “DAF Trust Trustee”) in order to ensure the provisions of the DAF Trust are followed. The DAF Trust could provide that the Donor’s children shall act through the DAF Trust Trustee. The DAF Trust Trustee would sign an agreement with the Donor to bind the DAF Trust Trustee to follow the direction of the Donor’s children or designated individual(s) upon the Donor’s death or incapacity. The DAF Trust would need to be funded with independent assets to pay the DAF Trust Trustee and there must be means to remove and replace the DAF Trust Trustee. The Charitable Sponsor would consider the requests of the DAF Trust Trustee and would not monitor the DAF Trust or the agreement entered into between the Donor and such DAF Trust Trustee. One Charitable Sponsor advised that the DAF Trust Trustee needs to be an individual who can share certain private identifiable information with the Charitable Sponsors to ensure they can have login credentials, including an address and any information that will help ensure that the DAF Trust Trustee can be located when it is time for them to serve as Successor Advisor, but that a social security number is not required. The authors believe that their clients may find such an agreement uncomfortable and fraught with operational issues. However, if a restrictive Charitable Sponsor will accept such an arrangement and the Donor prefers a DAF over a private foundation, the DAF Trust may be a consideration.
SURVEY QUESTION REVIEW
General Survey Questions
Will the Charitable Sponsor monitor the requests made by any Successor Advisor to determine they are to specified charities or for stated charitable causes as per the DAF Agreement?
Will the Charitable Sponsor enforce a cap on the percentage or dollar amount of charitable distributions that may be made to a single charity per year and an overall amount of annual grants based upon the DAF Agreement?
Will the Charitable Sponsor enforce the Donor’s objective as stated in the DAF Agreement that if there is more than one (1) Successor Advisor serving, such Successor Advisors must act unanimously if two (2) Successor Advisors are serving or by majority if more than two (2) Successor Advisors are serving?
Upon the Donor’s death or incapacity, can the first designated Successor Advisor designate such Successor Advisor’s successors? If so for how many generations?
If the first designated Successor Advisor does not designate such Successor Advisor’s successor, can Donor, via the DAF Agreement, designate a process of designating successors?
Can the Donor provide that upon the Donor’s death or incapacity the Fund shall be divided into equal funds for each of Donor’s children then living?
Can the Donor provide that if the Donor’s child who succeeds Donor cannot serve as Successor Advisor, such child’s children (i.e., Donor’s adult grandchildren born to such child who can no longer serve acting by majority) serve in such child’s place?
Can any serving Successor Advisor designate his or her successor? If so, for how many generations?
Will the Charitable Sponsor agree to the Donor’s default charitable beneficiaries if no Successor Advisor is able to serve so there is no possibility that the Charitable Sponsor will select charities to receive distributions?
If: (i) the Donor designates multiple levels of Successor Advisors and (ii) the Donor passes away, can the first designated Successor Advisor supersede the Donor’s list of Successor Advisors and appoint other persons as successors?
Can the Donor’s Successor Advisor(s) request distributions to any charities, regardless of whether such charities are those the Donor contributed to during the Donor’s lifetimes even if the DAF Agreement limits distributions to specified charities or specified causes?
Can the Donor and Successor Advisor(s) direct the DAF to another Charitable Sponsor regardless of whether such is authorized in the DAF Agreement?
Will the Charitable Sponsor enforce a provision in the DAF Agreement that at such time, if any, that the Donor’s children serve as Successor Advisors of their own separate fund, such child’s separate fund shall terminate upon such child’s death or upon the death of such child’s children (i.e., Donor’s grandchildren) at which time the remaining funds held in such child’s separate fund, if any, will be distributed to the organizations selected by the Donor during the Donor’s lifetime, which can be modified only by the Donor?
What is the DAF Default When DAF Grant Requests are No Longer Permitted by the Charitable Sponsor or No Successor Advisor is Able or Willing to Serve
A critical issue is how the DAF will be administered upon the death or incapacity of Donor and the Donor’s Successor Advisors. The authors received varying responses as follows:
Most Flexible: The Charitable Sponsor will distribute the remainder of the DAF in predetermined amounts or percentages as set forth in the DAF Agreement.
Moderately Flexible: The Charitable Sponsor will review prior charitable giving via the DAF report and distribute the remaining DAF funds to such organizations. The authors are uncertain whether such distributions would be made pro rata based upon prior charitable giving or in the discretion of the Charitable Sponsor and requested confirmation but have not yet received such.
Least Flexible: The Charitable Sponsor will become the Successor Advisor and will have absolute discretion over the DAF, including the ability to make grants to charities as the Charitable Sponsor decides (provided such charities are 501(c)(3) organizations) and at such time or times as the Charitable Sponsor determines. In such a situation, the Donor’s objectives are likely to give way to the objectives of the Charitable Sponsor. One DAF Agreement we reviewed provides as follows: “I also acknowledge that if I do not select a successor individual or entity for my fund, any remaining assets left in the fund after the passing of the last donor will be distributed into the [NAME OF ADMINISTRATOR] Charitable Gift Fund’s General Fund, which makes annual distributions to charitable organizations as determined by the Trustee ([NAME OF ADMINISTRATOR]).”
Of the nine Charitable Sponsors that answered the survey, national financial institutions that have created a nonprofit arm that serve as Charitable Sponsors fell into the Least Flexible category and Community Foundations fell into the Most Flexible category. However, some national financial institutions that strive to offer a more personalized experience fell into the Most Flexible or Moderately Flexible category. The authors believe clients should be aware of these issues so that they can proactively avoid a situation in which the Charitable Sponsor is the ultimate decision maker as to charitable donations.
Decisions by Multiple DAF Successor Advisors:
Charitable Sponsors responding to the survey provided a wide disparity on how multiple DAF Successor Advisors can provide charitable requests.
Most Flexible: The Charitable Sponsor will honor the Donor’s instructions that multiple Successor Advisors must act by majority vote as set forth in the DAF Agreement and will not make grants to charitable organizations until the Charitable Sponsor receives the necessary number of votes. One Charitable Sponsor advised that they are in the process of implementing technology that will flag when a grant requires the approval of multiple persons, send automated email alerts to each Successor Advisor that requests that such Successor Advisors log in and approve a pending grant request submitted, and will not move the grant request forward to their “Board of Trustees” until the Charitable Sponsor obtains such majority approval. Another Charitable Sponsor advised that if a Successor Advisors requests a charitable distribution and the DAF Agreement requires majority or unanimous vote, then the Charitable Sponsor will email all Successor Advisors and require that they each respond and provide consent, via email, before the grant request is evaluated and made.
Moderately Flexible: The Charitable Sponsor will attempt to honor the Donor’s instructions that multiple Successor Advisors must act by majority vote as set forth in the DAF Agreement in order for grants to be made to charitable organizations but is not willing to monitor that such majority votes are obtained before approving a grant request. One Charitable Sponsor likened the Charitable Sponsor’s limited ability to enforce a majority vote requirement to reviewing checks written by one of multiple account signatories, advising that when a check is written by one of multiple account signatories, they do not confirm that the other signatories on the account approve of such check. Although the author understands such comparison, they believe that account signatories are understood to have the ability to act unilaterally whereas the DAF Agreement would specifically provide that multiple Successor Advisors shall act by majority vote.
Least Flexible: The Charitable Sponsor will not honor the Donor’s instructions that multiple Successor Advisors must act by majority vote as set forth in the DAF Agreement or will not allow such a provision in the DAF Agreement. In the event multiple Successor Advisors are acting, any Successor Advisor may request a grant in any amount, even the full amount of the DAF assets, without the consent of the other Successor Advisors and the Charitable Sponsor can approve of such grant without considering the Donor’s instructions that multiple Successor Advisors act by majority vote or consulting with the other advisors. Thus, in the event three siblings are acting as Successor Advisors, if one sibling requests a charitable grant from the Charitable Sponsor of all the DAF assets, then the Charitable Sponsor may approve of such grant without contacting the other two siblings.
Monitoring of Grant Recommendations
The Charitable Sponsors responding to the survey also had a wide disparity as to whether they would consider the Donor’s DAF Agreement as to the types of charitable grants authorized from the DAF and annual caps upon the death or incapacity of the Donor.
Most Flexible: The Charitable Sponsor will limit grant approvals to specific charities or charitable purposes and to a percentage of DAF assets, such that if a grant request is made the request will be flagged with a “see DAF Agreement,” and a “board of Trustees” will review the grant request against the DAF Agreement before approving such. One Charitable Sponsor advised that they are in the process of implementing technology that will flag when a DAF Agreement has a cap on the amount an account can distribute over a set period of time and the amount each Successor Advisor can request be distributed.
Moderately Flexible: The Charitable Sponsor will not limit grant approvals to: (i) specific charities or charitable purposes or (ii) a percentage of the DAF assets but would require that at least two recommenders sign off on each grant.
Least Flexible: The Charitable Sponsor will not limit grant approvals in any way. The Successor Advisors may recommend grants to any charities in any amounts, regardless of the Donor’s instructions as set forth in the DAF Agreement. Consequently, the Donor’s successors could request, and the Charitable Sponsor could approve, grants to charities that the Donor would never have supported during the Donor’s lifetime.
Impact of Survey Results on Donors and Practitioners
It is important to note that the authors understand that the DAF Agreement is not a legally enforceable contract between the Donor and the Charitable Sponsor and the Donor’s only right is to request charitable donations. However, Donors who accept that proposition are willing to trust the DAF process should understand that some Charitable Sponsors are much more likely to satisfy the Donor’s charitable objectives and follow the terms set forth in the DAF Agreement after the Donor’s death or incapacity. Based upon the authors discussions with Charitable Sponsors, the authors have learned that some Charitable Sponsors will allow Donors to reflect all desires they may have in their DAF Agreement, but the Charitable Sponsor will not enforce such. Instead, the Donors DAF Agreement will be provided to the Donors’ successors upon the Donors’ death or incapacity as the Donors’ “letter of wishes” and the Donors successors are in no way obligated to follow the provisions set forth in the DAF Agreement. Further, in such cases, the Charitable Sponsor will not review the DAF Agreement when charitable requests are made to ensure that requests are being made in the manner provided in the DAF Agreement. Considering that most Donors believe that their DAF Agreement will be followed by the Charitable Sponsors, this information is extremely unsettling, and Donors should determine whether, and to what extent, their Charitable Sponsor will follow their DAF Agreement.
Practitioners should be aware of the issues described in this article and consider them for all clients who may have or are creating DAFs. Based upon the authors’ experiences, the authors suggest practitioners offer to review their clients’ DAF Agreements as part of their estate planning engagement. Practitioners should inform their clients of potential shortcomings of DAFs as compared to alternatives, such as private foundations, and discuss options with clients based upon the factors that are most important to the client. The larger the charitable contribution the more the client may prefer a private foundation as compared to a DAF after making an informed decision as to the benefits and drawbacks of each option. To the extent that the Donor’s current Charitable Sponsor is unwilling to work with the Donor to achieve the Donor’s objectives, the Donor may want to interview other Charitable Sponsors.
Conclusion
DAFs have been touted as an excellent alternative to foundations due to the administrative ease and cost. Although DAFs may have been considered initially for smaller gifts by those wanting to avoid the cost of creating and administering a foundation, the authors have seen increased interest from clients who intend to fund DAFs with gifts in excess of $1 million (some with as much as $100 million). Some Charitable Sponsor may be over-marketing DAFs as compared to foundations for larger gifts, and financial advisors should clearly advise clients when comparing DAFs to foundations as discussed in this article. While administrative ease, cost, and additional tax flexibility may provide good reason to consider DAFs, the devil is in the details and clients need to consider how their DAFs will be administered after their death or incapacity in order to make an informed decision.
Donor Advised Funds Table of Questions - VIEW PDF
Definitions
“Advisory Rights” shall refer to the right to recommend, but not direct, grants from the DAF to 501(c)(3) charitable organizations.
“Charitable Sponsor” shall refer to the Donor Advised Fund administrator.
“DAF Agreement” shall refer to the Donor Advised Fund Agreement, entered into by the Donor and the Charitable Sponsor.
“DAF” shall refer to donor advised fund.
“Donor” shall refer to the individual or individuals who set up (i.e., created and made the donation to) the Donor Advised Fund.
“Initial Successor Advisor” shall refer to the first level successor advisor, who shall serve (i.e., recommend distributions from the DAF) upon such time that no Donor is living or capacitated.
“Successor Advisor” shall refer to successor advisors to the Donor, who shall serve (i.e., recommend distributions from the DAF) upon such time that no Donor is living or capacitated.
HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!
Cassandra Nelson
Barry Nelson
CITE AS:
LISI Charitable Planning Newsletter #330 (November 6, 2023) at https://www.leimbergservices.com. Copyright 2023 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited - Without Express Permission. This newsletter is designed to provide accurate and authoritative information regarding the subject matter covered. It is provided with the understanding that LISI is not engaged in rendering legal, accounting, or other professional advice or services. If such advice is required, the services of a competent professional should be sought. Statements of fact or opinion are the responsibility of the authors and do not represent an opinion on the part of the officers or staff of LISI.
CITATIONS:
[1] National Philanthropic Trust, The 2022 DAF Report (2022), available at https://www.nptrust.org/reports/daf-report/#:~:text=DAFs%20reached%20a%20new%20record,of%20the%20COVID%2D19%20pandemic
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Disclaimer: This information has been prepared for educational purposes only and is not offered, nor should be construed, as legal advice. Use of this information without careful analysis and review by your attorney, CPA, and/or financial advisor may cause serious adverse consequences. We provide absolutely no warranty or representation of any kind, whether express or implied, concerning the appropriateness or legal sufficiency of this information as to any individual’s tax and related planning.
