" It just feels like if his college expenses were paid 100% by his 529 account that it wouldn't be appropriate to take an education credit"
Yes, at first glance. But if he uses $4000 tuition to claim the credit, he gets $2500 (assuming he has a tax liability of at least $1500). You pay tax on only the earnings portion of $4000 (not the full $4000, see example above). So, say about $2000 taxable income at 12% = $240. The family comes out about $2000 ahead. That is allowed. It's not only allowed, it's encouraged. The 10% penalty is even waived (the tuition credit exception).
If you were the recipient (not him), it's fairly easy to enter in TT, because he's not your dependent.
Enter the 1099-Q. When asked who the student is answer: someone else not listed here. Enter the student's name when asked. A few screens later, you'll get one simple screen to enter expenses. Also $4000 in the box "Tax-free assistance". This reports the earnings as taxable and claims the tuition credit exception. You do not have to deal with the complicated “Educational expenses and Scholarships” (1098-T) section later. TT will prepare form 5329 to claim the penalty exception.
