Education

I do believe you could do it that way, scholarship to room and board and then the student claims the excess 529 distribution. (IF THE SCHOLARSHIP WAS NOT RESTRICTED TO PAYING TUITION EXCLUSIVELY)

The penalty tax on the 529 distribution would be waved because of the scholarship. 

This is what I base my answers on:

According to the IRS PUB 970 Page 16: 

“Coordination with Pell grants and other scholarships. You may be able to increase your American opportunity credit when the student (you, your spouse, or your dependent) includes certain scholarships or fellowship grants in the student's gross income. Your credit may increase only if the amount of the student's qualified education expenses minus the total amount of scholarships and fellowship grants is less than $4,000. If this situation applies, consider including some or all of the scholarship or fellowship grant in the student's income in order to treat the included amount as paying nonqualified expenses instead of qualified education expenses. Nonqualified expenses are expenses such as room and board that aren't qualified education expenses such as tuition and related fees.”

From this I believe scholarship funds must be matched to education expenses "Qualified" or "Non-qualified"

However on page 54 of Pub 970 it states: 

"Coordination With American Opportunity and Lifetime Learning Credits The American opportunity or lifetime learning credit can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, as long as the same expenses aren't used for both benefits. This means the beneficiary must reduce qualified higher education expenses by tax-free educational assistance, and then further reduce them by any expenses taken into account in determining an American opportunity or lifetime learning credit. Example. Derek Green had $5,800 of qualified higher education expenses for 2020, his first year in college. He paid his college expenses from the following sources. Partial tuition scholarship (tax free) $1,500 Coverdell ESA distribution 1,000 Gift from parents 2,100 Earnings from part-time job 1,200 Of his $5,800 of qualified higher education expenses, $4,000 was tuition and related expenses that also qualified for an American opportunity credit. Derek's parents claimed a $2,500 American opportunity credit (based on $4,000 expenses) on their tax return. Before Derek can determine the taxable portion of his Coverdell ESA distribution, he must reduce his total qualified higher education expenses. Total qualified higher education expenses $5,800 Minus: Tax-free educational assistance −1,500 Minus: Expenses taken into account in figuring American opportunity credit − 4,000 Equals: Adjusted qualified higher education expenses (AQHEE) $ 300 Since the adjusted qualified higher education expenses ($300) are less than the Coverdell ESA distribution ($1,000), part of the distribution will be taxable. The balance in Derek's account was $1,800 on December 31, 2020. Prior to 2020, $2,100 had been contributed to this account. Contributions for 2020 totaled $400. Using the four steps outlined earlier, Derek figures the taxable portion of his distribution as shown below. 1. $1,000 (distribution) × $2,100 basis + $400 contributions $1,800 value + $1,000 distribution = $893 (basis portion of distribution) 2. $1,000 (distribution) − $893 (basis portion of distribution) = $107 (earnings included in distribution) 3. $107 (earnings) ×    $300 AQHEE    $1,000 distribution = $32 (tax-free earnings) 4. $107 (earnings) − $32 (tax-free earnings) = $75 (taxable earnings) Derek must include $75 in income (Schedule 1 (Form 1040), line 8). This is the amount of distributed earnings not used for adjusted qualified higher education expenses."

Therefore I believe if the scholarship can be applied to the room and board (NONQUALIFING EDUCATION EXPENSES) the excess 529 distribution can be claimed by the student and the penalty tax is waved since the room and board was paid for with the scholarship. 

Additionally, the tax on the distribution is only on the earnings portion, so better than claiming the scholarships. 

I have also included a link to an IRS Topic which states how scholarships must be reported: 

IRS Topic 421