Does my daughter need to file a return for her 529 distribution

Q.  Does my daughter need to file a separate tax return on her own for the 529 plan distribution.

A. Probably not; but it's complicated. For sure, not all of the $5949 earnings will be taxable. Even if she owes no tax, you may want to have her file to "document things". I assume student is "recipient" of 1099-Q, not grandparent-owner. 

There are three things you can do with your Qualified educational expenses (QEE):

1. Allocate then to scholarships (so that the scholarship remains tax free)
2. Use them to claim an education credit
3. Allocate them to the 529 distribution (1099-Q) so that it will not all be taxable

Room and board, as well as books, computers and other required course materials are also QEE for the 529 distribution.   Most people come out better having the scholarship taxable before the 529 earnings.  You're allowed to do this, as long as the scholarship is not restricted to being used for tuition.   As long as the taxable scholarship is less than $12,400, technically a return is not required.  However, taxable 529 earnings of more than $1100 require a return. 

_____________________________________________________________________________________________

Qualified Tuition Plans  (QTP 529 Plans) Distributions

General Discussion

It’s complicated.

For 529 plans, there is an “owner” (usually the parent, but can be grandparent), and a “beneficiary” (usually the student dependent). The "recipient" of the distribution can be either the owner or the beneficiary depending on who the money was sent to. When the money goes directly from the Qualified Tuition Plan (QTP) to the school, the student is the "recipient". The distribution will be reported on IRS form 1099-Q. 
The 1099-Q gets reported on the recipient's return.** The recipient's name & SS# will be on the 1099-Q.
Even though the 1099-Q is going on the student or grandparent's  return, the 1098-T should go on the parent's return, so you can claim the education credit. You can do this because she is your dependent.

You can and should claim the tuition credit before claiming the 529 plan earnings exclusion. The educational expenses they claim for the 1099-Q should be reduced by the amount of educational expenses you claim for the credit.
But be aware, you can not double dip. You cannot count the same tuition money, for the tuition credit,  that gets him an exclusion from the taxability of the earnings (interest) on the 529 plan. Since the credit is more generous; use as much of the tuition as is needed for the credit and the rest for the interest exclusion. 

Total qualified expenses (including room & board) less amounts paid by scholarship less amounts used to claim the Tuition credit equals the amount you can use to claim the earnings exclusion on the 1099-Q. 
Example:
  $10,000 in educational expenses(including room & board)

   -$3000 paid by tax free scholarship***

   -$4000 used to claim the American Opportunity credit

 =$3000 Can be used against the 1099-Q (usually on the student’s return)

Box 1 of the 1099-Q is $5000

Box 2 is $2800

3000/5000=60% of the earnings are tax free; 40% are taxable

40% x 2800= $1120

You have $1120 of taxable income  

**Alternatively; you can just not report the 1099-Q, at all, if your student-beneficiary has sufficient educational expenses, including room & board (even if he lives at home) to cover the distribution. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. Again, you cannot double dip!  When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms. But, it will prepare a 1099-Q worksheet for your records, in case of an IRS inquiry.

On form 1099-Q, instructions to the recipient reads: "Nontaxable distributions from CESAs and QTPs are not required to be reported on your income tax return. You must determine the taxability of any distribution." 

***Another alternative is have the student report some of his scholarship as taxable income, to free up some expenses for the 1099-Q and/or tuition credit. Most people come out better having the scholarship taxable before the 529 earnings.