Usually, you must deduct the Box 5 amount from the box 1 amount to use for the Lifetime Learning Credit (LLC).
There is a tax “loop hole” available to claim an education credit, for the parents of students on scholarship. The student reports all his scholarship, up to the amount needed to claim an education credit, as income on his return. That way, the parents (or himself, if he is not a dependent) can claim the tuition credit on their return. They can do this because that much tuition was no longer paid by "tax free" scholarship. You cannot do this if the conditions of the grant are that it be used to pay for qualified expenses.
Using an example: Student has $10,000 in box 5 of the 1098-T and $11, 000 in box 1. At first glance he/she can only use $1000 to claim the credit. But if she reports $9,000 as income on her return, the parents can claim $10,000 of qualified expenses on their return. The Lifetime Learning credit (LLC) is 20% of tuition paid. So, if you are only in the 12% tax bracket, you will come out ahead. The LLC is a non refundable credit. That is, it can only be used to offset an actual tax liability.
The IRS actually encourages use of this technique. From the form 1040 instructions: “You may be able to increase an education credit if the student chooses to include all or part of a Pell grant or certain other scholarships or fellowships in income. For more information, see Pub. 970, the instructions for Form 1040 and IRS.gov/EdCredit". PUB 970 even has examples of how to do the “loop hole”.
