@MarilynG1 brings up a good option.
If her scholarship was not restricted to being used for tuition, you have the option of having her declare some of her scholarship as taxable income, rather than you paying tax on the 529 plan earnings. That is, you shift some of the qualified expenses from the scholarship to the 529 distribution*.
Why is this a better option?
Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $12,950 filing requirement and the dependent standard deduction calculation (earned income + $400). It is not earned income for the kiddie tax and other purposes (EIC, IRA contributions). So, depending on how much other income she had, she can declare up to $12,950 of her scholarship as taxable and still not pay any tax on it.
*There are three things you can do with your Qualified educational expenses (QEE):
- Allocate then to scholarships (so that the scholarship remains tax free)
- Use them to claim an education credit
- Allocate them to the 529 distribution (1099-Q) so that it will not all be taxable
