Unless you provide them with a 1099 or whatever IRS filing form may be required (if one is), the return of their donation will not be subjected to tax or penalty because obviously it cannot be considered as income.
I would also consult with your State's Attorney General's office regarding the refunds.
Pam
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Obviously the IRS will want back any tax that was not paid because of any deduction for the donation.
A tax advisor would give an opinion as to whether this would be handled with an amended return or as miscellaneous income in the year if the return of the donation. Interest might be due.
It is unlikely that there would be a penalty unless it appeared that this was part of a tax avoidance scheme. Proper documentation of the refunding should be left to professionals.
The institution should suggest consulting a tax advisor rather than giving an opinion itself, at least in writing. The best handling of the transaction may depend on the individual circumstances of the donor.
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