Tax questions regarding nonqualified distributions from 529
My oldest son will be my tax dependent this year. He is single, 24, and not blind.
I am considering taking a non-qualified withdrawal from his 529 this year.
According to Pub 970 Chapter 8, this withdrawal would result in taxable income to him which would be reported on Schedule 1 line 21 (using 2018 tax form line numbers).
Question 1: Would this income be considered earned income or unearned income (or neither?) for the purposes of looking at Chart B for Dependents in the Form 1040 instructions when deciding whether or not he needs to file?
I'd like to take the position that it is earned income, because it would be similar to "taxable scholarships and grants" listed at the top of Chart B.
Also according to Pub 970 Chapter 8, there is "generally" an additional 10% tax on withdrawals with a list of five exceptions, with tax free scholarships being exception 3a. My son has received scholarships that would qualify him for exception 3a.
If we treat this withdrawal as earned income, then according to Chart B my son would not be required to file an income tax return because his earned income would be below the ~$12K limit.
Question 2: If my son is not required to file an income tax return, then does it follow that he would not have to pay the additional 10% tax on withdrawals?
My son plans to attend college full time next year and will probably have close to zero earned income. (He may earn a few thousand in an internship.)
I plan to give my son the left over balance of his 529 next year when he graduates. He plans to liquidate the 529 and put it into his house down payment funds (he has no plans for children and no plans for graduate school). That liquidation event will be a non-qualifying distribution as well.
Question 3: If he doesn't have to pay the additional 10% tax on withdrawals, does that mean that he can fully preserve his "exception 3a" qualifying scholarships for next year's liquidation event so he doesn't pay the 10% penalty next year?
"At times the world can seem an unfriendly and sinister place, but believe us when we say there is much more good in it than bad. All you have to do is look hard enough, and what might seem to be a series of unfortunate events, may in fact be the first steps of a journey." Violet Baudelaire.