My client pulled money out of a 529 plan that was set up for her granddaughter. The granddaughter received a scholarship. How is this reported so there is no 10% tax?

Because it is a specific exception to the 10% tax in Pub 970 "A tax-free scholarship or fellowship grant"

sjrcpa said:

Why shouldn't there be tax and penalty?

The money was not used for qualified education expenses.

AJMorris said:

Because it is a specific exception to the 10% tax in Pub 970 "A tax-free scholarship or fellowship grant"

Not enough info to answer the question, or at least it is not clear.  I am reading the original post to mean the funds for ALL years covered by the scholarship were withdrawn after graduation.

The withdrawal exception allows for funds to be withdrawn annually each year of the scholarship.  In fact, research on Q withdrawals suggest even a Q withdrawal on December 30th with qualified expense payment on January 2nd is an issue, meaning the years must match up.  In the case posed, it appears a much longer mismatch period is involved.  Does it make sense to leave a 529 in place after the intended student graduated and then in subsequent years claim the money is tax-free on withdrawal?  Of course not.  BTW, the program believes the funds need to be withdrawn annually as well.  Fill out the Q worksheets and link to the education worksheets for that student.  The qualifying expenses are those paid in that year, not a co-mingling of expenses from several years.  The Q form is for distributions in a specific year and the 1098T form is for qualified expenses paid in that year.  Other expenses, such as room and board which can be used for Q purposes, are also year specific.  Given how tax law works generally, that make sense.

Absent more info or clarification on what specifically is being asked, @sjrcpa is correct.