Greetings Scott!
Unfortunately, there is no clear guidance on this issue from the IRS. This is an older article, but the information is still applicable: http://www.bankrate.com/finance/college-finance/tax-code-squishy-on-529-plan-withdrawal.aspx
I know this isn't a clear answer, but I hope it is helpful as you make your decision. If you're definitely closing out the account no matter what, it would make sense to claim all of the exemptions. Worst case scenario is you have to have some conversations with the IRS and provide documentation showing the scholarships received.
Yes; the penalty exception is just that, an exception to the additional penalty tax on earnings. The recipient will still be responsible for tax on earnings at the time of the withdrawal. So if he is in a lower tax bracket now it might be the right time. However, you don't have to make the withdrawal- ever. You could just sit on the assets in case he goes for a Masters or other advanced degree in the future.
Good luck,
Brian Boswell
VP, Research & Development
This information does not constitute tax advice and is provided for informational purposes only. Please consult your tax advisor, financial advisor, local taxing authority, and/or plan provider or sponsor for more information.