Education

I just discovered your follow-up to my question.  It's still not clear to me that just because 529 withdrawals must be matched with eligible expenses in a given year for those withdrawals to be non-taxable, that "matching" provides the answer to taxation of scholarship offsets.

The purpose of a withdrawal based on past scholarships is NOT to cover eligible expenses.  The purpose is to note that past eligible expenses that could have been covered using 529 withdrawals were instead covered by contemporaneous scholarship funds.  Perhaps one has to document that matching for a past tax year (or be prepared to document it), but a scholarship is a source of funds, not an expense.  If one at the end of college prudently did not liquidate 529 funds until college was paid for, there may never be future eligible education expenses (ignoring beneficiary changes, etc.).  The tax policy should not require withdrawing 529 money as scholarships are received in the same year, because it effectively penalizes scholarships:  the price of using a scholarship becomes not being able to continue saving current 529 funds that might be needed in the future (unless one is prepared to pay withdrawal penalties in future years despite the intent to waive penalties where scholarship money changes the need for 529 funds).

The only policy argument I see on the flip side is (i) multiyear documenting is burdensome to IRS for old scholarships and (ii) once a scholarship arrives, 529 money should not continue to be invested tax-free only to be withdrawn tax-free years later--either withdraw it when the scholarship is received as a one-year opportunity or lose the ability to have the scholarship recognized as the reason for "excess" 529 money.

As far as I can tell, after all these years, the IRS has intentionally not stated a clear position on this.