529 account over-contribution & 10% extra tax on earnings

full-ride scholarship, leaving excess funds in his 529 account that I would like to move to my retirement account. I am owner of the 529. I know I could transfer it to another family member, but that is not useful in my situation. My question is how much of the 529 holdings can be distributed without incurring the 10% additional tax on earnings. IRS pub 970 Ch 8, Additional Tax on Distributions, #3.a, provides for an exception to the penalty if the distribution is included in income due to receipt of a tax-free scholarship or fellowship. But pub 970 Ch

1 says room & board is not a qualified use of tax-free scholarship. If I understand correctly, the beneficiary can take a tax-free distribution equal to the amount of qualified tax-free scholarship received, but not the entire amount that would have been qualifed under 529. For example, let's say this happens for 2013:

incurring the 10% penalty on earnings since $5k is considered qualified for tax-free scholarship?

of this provision to allow me to get the funds back since they're not needed for college?

could gift it back to me, correct?

Your post is confusing because you first ask about the 10% additional tax and you later discuss tax-free distributions. The 10% additional tax is just that... a tax that is in addition to your mormal tax that has to be paid on a distribution that includes earnings that is not used for qualified expenses. You can avoid the 10% additional tax if the reason is triggered by a tax-free scholarship. You don't avoid the normal tax on the earnings.

In addition, you have not told us how much of the account balance is principal that you have already paid taxes on and how much is earnings on which no taxes have been paid.

So... I will give you an example that may help you. Let us assume you have a balance in the account of $20000. That balance consists of $15K you contributed after-tax and $5K of untaxed earnings. Let us also assume that during the tax year, qualified tuition and fees are $5K, "allowable" room and board is $5K, there is a pell grant for $5K and you withdraw the total amount of $20K and close the account.

The QTP adjusted qualified ed. expense (AQEE) is $5K ($5k tuition + $5K allowable room & board less $5k scholarship). The total amount of earnings ($5K) withdrawn is multiplied by the AQEE of $5K over $20K (5/20) to determine the tax-free portion. $5K times .25 = $1250 tax free gross income to the beneficiary (your child). The remainder of $3750 is the taxable gross income that your child would have to declare on page 1 of his/her 1040. The 10% penalty is NOT waived because the $20K distribution exceeds the pell grant of $5k. The penalty of $375 (10% of $3750) is computed in Part II of the child's Form 5329.

I always recommend that you have the QTP send a check made out to the student beneficiary. The child merely endorses the check over to you. The 1099-Q will be issued under the child's SSN.