But scholarships above tuition and books are taxable and have been for a long time. (I paid in the 1990s) They are considered earned income in IRS publication 929 in the definitions section. Plus, 529 distributions have a formula that means you can take out the value of certain scholarships penalty free. It has to do with the portion that was earnings vs. deposit.
D17 started filing taxes every year at 18 because the income from the value of room and board put her at paying more than half her annual support. I mean, if someone is on a full ride, what is the support from the parents?
If I were OP, I would read ALL the publications that deal with child/dependent income (929 among others) and to do with 529 distributions and taxes/penalties. Then do the numbers by hand and see what you should do. We still do taxes by hand, so that is what we did to maximize transferring the money out of the 529 while minimizing taxes, but she did pay taxes on the earnings portion.
They really want to have people save in the 529, so they make it sort of easy to take the amount of the scholarships back out, but it is NOT simple and is filled with contradictions. Also read IRS 970 (section on QTPs) and do all the calculations- in each booklet be sure to read what counts as earned income and what does not. It literally changes from calculation to calculation!
Most important- the value of room and board and extra IS taxable whether you offset the 529 or not! (See IRS topic 421) It is easier to take the 529 money out without penalties while they are getting the scholarship as far as we could tell. BUT- as with all things taxes, every person and website and professional gives a different answer, so we just printed all the booklets to keep for proof in an audit of how we came up with our numbers and did it by hand.
** Important- I am not a tax person at all.