Q1. He received several academic scholarships so can I take that money out of my 529?
A1. Yes, but you must take the money out by year end, to qualify for the scholarship penalty exception. Having received scholarships, in the same amount as the distribution is an exception to the 10% non-qualified distribution penalty. Income tax will still be due on the distribution. The scholarship is just an exception to the penalty, not the tax.
Q2. If I want to remove the excess funds, how would I be taxed? Am I only taxes on the earnings portion and if so, at what rate?
A2. Yes, only the earnings is taxed (and/or subject to the penalty). It is taxed as ordinary income, at your marginal tax rate.
Q3. Also, is there a certain form I have to use to report it and pay the taxes?
A3. TurboTax calculates the taxable amount on a work sheet, that is not sent to the IRS. The taxable amount is reported on line 8z of Schedule 1. Form 5329 is filled out to report any penalty or claim an exception (e.g. the scholarship exception) to the penalty. TurboTax does all this, but it can get tricky. It’s helpful, if you have an idea of the expected outcome. In your case, the earnings (box 2 of the 1099-Q) on line 8z of Schedule 1 and form 5329 generated to claim the penalty exception.
Another option for money left over in a 529 plan is to change the beneficiary to another family member, siblings of the beneficiary being the most common change. For details, see: https://www.thebalancemoney.com/transferring-529-plans-to-another-beneficiary-4157853#:~:text=How%20....
