Q. It seems I can only use funds for the months of school that she attended during the current tax year (January 2023) but not previous years. Is this accurate?
A. Yes. The withdrawal ("distribution") must be in the same calendar year that the tuition was for and was paid*. But the distribution can be received after the tuition was actually paid. For example, if the tuition was paid, in January 2023, for the 1st term on 2023, the grandparents can take the distribution any time in 2023. But, if the payment (for the 1st term of 2023) was made in December 2022, they may not use a 2023 distribution for reimbursement.
Q. My understanding is that it doesn't matter where she went to school, my parents would not be taxed or penalized for the withdrawals. Is that correct?
A. Yes.
The $10k per beneficiary, per year, limit for K-12 education applies to federal income tax as well.
You say "Her HS is willing to work with me".
For 529 plans, there is an “owner” (usually the parent, but in this case the grandparent), and a “beneficiary”. The "recipient" of the distribution can be either the owner or the beneficiary depending on who the money was sent to. When the money goes directly from the Qualified Tuition Plan (QTP) to the school, the student is the "recipient". The distribution will be reported on IRS form 1099-Q.
The 1099-Q gets reported on the recipient's return. The recipient's name & SS# will be on the 1099-Q. Alternatively, the recipient can just not report the 1099-Q, at all, if your student has sufficient K-12 tuition, to cover the distribution (up to the $10K limit). Since the distribution is a qualified (non taxable) distribution, it really doesn't matter who the recipient is.
*There is one exception to the the matching year payment rule. You may pay for the first term of 2023 in 2022 and that will be a qualified payment. But the 529 distribution must still match. That is, if you made the payment in 2022 (even of the 1st term of 2023), you must take the distribution in 2022, for it to be qualified. The reverse is not true (you may not wait until 2023 to pay the 2022 tuition and claim it as a qualified distribution).
