Q. Do we have to file a separate tax return for the youngest if she had no earned income for the year?
A. It depends on how substantial those scholarships are and how big the disbursement from the 529 account is in comparison the expenses allocated to it. Earned income from wages and scholarships are not taxable up to $13,850. But unearned income, such as the non qualified portion of a 529 distribution is taxable at a level of only $1250.
Q. If not, how do I handle the tax forms she received from her university?
A. The 1099-Q and the 1098-T are only informational documents. The numbers on them are not required to be entered onto your (or your student's) tax return.
The numbers on a 1098-T are not required to be entered onto your tax return. However receipt of a 1098-T frequently means you are either eligible for a tuition credit or possibly your student has taxable scholarship income.
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You claim the tuition credit, or report scholarship income, based on your own financial records, not the 1098-T. But, if you claim the tuition credit, you do need to report that you got one
You can just not report the 1099-Q, from a 529 Plan distribution, if your student-beneficiary has sufficient educational expenses, including room & board (even if he lives at home) to cover the distribution. When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms.
So, you need to determine if you have anything to report. If scholarships exceed qualified educational expenses, the excess should be treated as income. If 529 distributions exceed qualified educational expenses, a portion of the earnings can be taxable. You cannot "double dip", that is you cannot claim the same expenses as being covered by both scholarship and the 529 distribution.
