This is a gross overgeneralization. The complicated answer is, it depends. It depends on how you want to define “overfunded,” how generous a school is with institutional need-based aid, and a lot of other factors. Some schools in calculating institutional need-based aid will categorize a student accessible 529 account as a parent asset, and ding it at the same 5.64% maximum that FAFSA does. This means that a 529 account with a balance of $200,000 might only attribute to the student an expected contribution of $11,280 from that account. Many students who have access to large 529 accounts still receive significant institutional need-based aid.
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The person responsible for reporting the non-qualified distribution on a tax return will be the person to whom the non-qualified distribution was paid, as indicated by the 1099-Q issued by the account administrator after the tax year ends. So yes, there is flexibility, which is based on to whom the account owner or custodian requests the distribution go.
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How about if it goes directly to the school, and then the school refunds the money?
Folks on here are generally happy to advise, but you may want to consult with an accountant. We did that last year. Just a 1 time consulting fee fora hour meeting and got lots of questions answered.
That’s true and we probably will. It’s just tricky to find a CPA who also knows financial aid. 
A 529 distribution sent directly to the school by the account administrator is treated the same way as if it had been sent to the student. If the school subsequently refunds money that can reasonably be considered part or all of a payment made using 529 funds, the best thing to do (usually) is to return the refunded money to the 529 account within 60 days after the date of the refund, and in such case you can avoid the need to figure the taxable part of the distribution (it’s like the distribution of the refunded money never happened).
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Yes, there are folks here who are happily advising, you and me included.
That being said, I agree that trusting anonymous posters on an internet forum is not generally advisable, especially when it comes to significant financial matters.
Of course! And I try to always find corroborating, official resources – but the advice here helps me know where to look and, sometimes, what search terms to use!
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The information concerning 529 recontributions of college refunds can be found on page 51 of IRS Pub 970:
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Thank you!
If you have time, can you also tell me where to find the verbiage that treats need-based aid the same as “scholarships”.
It’s the opposite- there is no language saying there is a distinction between merit aid and need-based aid. Absent any such language, these two different types of higher education aid should be treated the same for 529 purposes. Also, the label “scholarship” cannot/should not be used to distinguish between merit and need-based aid. Need-based aid is very often described as a scholarship, sometimes in explicit terms.
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Thank you so much. I have read this document several times and couldn’t find that information. And ALL the websites from financial advisors etc that I have found always use the term “scholarship”, which I had thought only meant merit-aid.
From Chapter 1 of Pub 970 (“Scholarships, Fellowship Grants, Grants, and
Tuition Reduction”):
Pell Grants and Other Title IV Need-Based Education Grants
These need-based grants are treated as scholarships for purposes of determining their tax treatment. They are tax free to the extent used for qualified education expenses during the period for which a grant is awarded.
Thank you. We didn’t qualify for a Pell grant, but are receiving need-based institutional aid from one of the more generous CSS-Profile schools. It makes sense that the term “scholarship” would apply to the institutional aid as well.
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Yes, I agree. The quoted language from Pub 970 Chapter 1 refers only to federal need-based aid, but it seems logical to treat institutional need-based aid the same way. Note that Chapter 1 has to do with the taxability of scholarships (to include need-based aid), but because the chapter on 529s says nothing about a distinction between merit and need-based aid when the 10% penalty exception is discussed, it makes sense to apply the exception rule to all types of aid.
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on the 1098-T, the schools treat federal aid (SEOG, Pell) the same as institutional aid (same box).
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