The 1098-T is only an informational document. The numbers on it are not required to be entered onto your tax return. However receipt of a 1098-T frequently means you are either eligible for a tuition credit or possibly your student has taxable scholarship income.
If you claim the tuition credit, you do need to report that you got one or that you qualify for an exception (the TurboTax interview will handle this)
You claim the tuition credit, or report scholarship income, based on your own financial records, not the 1098-T.
You need to claim $4000 of tuition in order to get the maximum ($2500) American Opportunity tax credit (AOTC) on your tax return. Based on the numbers you provided, you enter the 1098-T, as received. When asked how much of the scholarship was for room & board, you enter $5500 (the $1500 that box 5 exceeds box1 + the $4000 you need for the credit). That gets you the $2500 credit and yes, that's legit*.
On her return, she needs to report $5500 of scholarship income**. Despite the fact that she had a $9K scholarship just for room & Board, you are allowed to allocate some of that $9,000 to tuition and other qualified expenses (tuition, fees, books & a computer) actually paid.
Q. " My understanding is that room and board scholarships are taxable."?
A. Not exactly. Total Scholarships that exceed Qualified Expenses is taxable. Room & board are not "qualified" expenses.
*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 this.
** Enter the 1098-T, exactly as received, on the student's return. Enter book expenses separately (you may be able to reduce the $5500). In his/her interview, you should eventually reach a screen called "Amount used to calculate education deduction or credit". Be sure the amount in that box is $4000. That will put all his excess scholarship as income on his return. Note: don't enter anything for amount of scholarship used for room & board; that will duplicate the $5500.
Be advised some people are saying they're not getting the "Amount used to claim the tuition deduction or credit" screen on the dependent’s interview. Check the student information work sheet (part VI, line 17) to verify it was entered. If not, the alternate workaround is to enter $4000 less than the actual box 1 amount, when you enter the 1098-T.
There's yet another (and simplest) work around. Manually calculate the taxable amount of scholarship and enter the 1098-T, on his return, with 0 in box 1 and the taxable amount in box 5.
