Q. Since you say that is tax free, what should I do about any of it?
A. Only part of the scholarship is tax free. The term "full ride" usually means the scholarship pays for room and board, as well as tuition.
A simple rule is that the taxable portion of a scholarship is the difference between the amount shown in box 5 of the 1098-T and the amount shown in Box 1 (assuming box 5 is the larger number). That difference can be reduced by the cost any books and computers not already included in box 1.
If that difference is more than $12,550, she has to file a tax return.
You say Her parents are not able to claim education credits. If their income is too high, that is correct. If you say that because her tuition was paid by scholarship, there may be a way around that, See below.
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There is a tax “loop hole” available. The student reports all his scholarship, up to the amount needed to claim the American Opportunity Credit (AOC), 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 school’s billing statement specifically shows the scholarships being applied to tuition or 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 $8000 in box 1. At first glance he/she has $2000 of taxable income and nobody can claim the American opportunity credit. But if she reports $6000 as income on her return, the parents can claim $4000 of qualified expenses on their return.
Books and computers are also qualifying expenses for the AOC. So, extending the example, the student had another $1000 in expenses for those course materials, paid out of pocket, she would only need to report $5000 of taxable scholarship income, instead of $6000.
