Income of a child is never reported on a parent's tax return, unless the only income is interest and dividends for investments in the child's name. Since this is IRA income, each child must file their own tax return. There is no 10% penalty for early withdrawal, the money is taxed as ordinary income, assuming it came from a traditional (pre-tax) IRA. (If this is an inherited Roth IRA, it is not taxable at all.)
However, because this is unearned income and they are under age 24, they may be taxed at a higher rate under the "Kiddie tax." See here.
https://www.irs.gov/taxtopics/tc553
Note that your children must follow the 10 year rule for inherited IRAs, meaning they must withdraw all the money and close the accounts within 10 years (2032). If the grandmother was older than her beginning year for RMDs, the children must withdraw at least as much as their RMD, starting in 2024 (they can withdraw more, of course). Depending on the value of the account, you may want to do some financial planning so the children make most of their withdrawals when their income taxes are lowest. Because of the kiddie tax, their lowest tax rate between now and 2032 will probably be when they turn 24, so they might pay less tax if they can hold onto the money until then. But there may be other consideration, of course. If it's a lot of money, you might want to talk to a financial planner or your own tax professional.
