The term "financial aid" includes both loans and scholarships/grants. Loan money is not taxable, regardless of how it is used. Scholarships are only taxable to the extent that the amount exceeds you qualified educational expenses (QEE) (tuition, fees, books and other course materials). Room and board are not QEE for either scholarships or education credits. R&B are qualified expenses for a 529/ESA/QTP Plan distribution, if the student is at least half time. QEE paid by loans qualifies for a tuition credit.
Your college does not report excess financial aid refunds to the IRS, except when a 1098-T is issued.
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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.
